Dollar Rally Derailing S&P 500 Record Run as Correlation BreaksAndrea Wong and Joseph Ciolli
The rare occurrence of the dollar and stocks rallying simultaneously is proving to be short-lived amid concern the strengthening U.S. currency will sap corporate profits.
The greenback and the Standard & Poor’s 500 Index each staged rallies in the past five months, a feat not seen since 1999. The correlation broke this month as the Federal Reserve cited the dollar rally while cutting its outlook on growth, prompting analysts to forecast lower earnings for the first time since 2009.
“It’s not going to come back anytime soon,” Athanasios Vamvakidis, head of Group of 10 foreign exchange strategy at Bank of America Merrill Lynch in London, said in a phone interview. “The dollar is now at the level where further appreciation will lead to a level that’s overvalued and will start to have a negative impact on U.S. equities.”
The dollar’s ascent, which analysts expect will continue into 2016, is exacerbating the concern of equity investors as they contemplate the end of the zero-interest-rate monetary policy that has fueled a 205 percent rally in the S&P 500 since the start of the six-year bull market in March 2009. The negative drag of the stronger dollar is already trickling through the economy as exports become less competitive and imports more attractive to consumers.
The 120-day correlation coefficient between the Bloomberg Dollar Spot Index and the S&P 500 fell to minus 0.05 on March 27, indicating movements of the two aren’t connected. The measure rose to as high as 0.3 two months ago, showing the correlation had a positive relationship.
The best growth among developed countries led investors to pile into U.S. assets, underpinning both the dollar and American equities. That correlation, which lasted for almost five months, was non-typical. The greenback, usually viewed as refuge by investors, would typically appreciate as stocks and other riskier assets fell, and vice versa.
The last time the two assets rose in tandem for an extended period was from September 1998 until the Internet-company fueled dot-com bubble burst, with the S&P 500 tumbling 26 percent from March 2000 through the end of 2001, while the trade-weighted dollar strengthened more than 10 percent.
The U.S. central bank should raise interest rates now before a “significant asset-market bubble‘‘ develops, Fed Bank of St. Louis President James Bullard said last week. Signs of stress has already emerged in equities, as the S&P 500 had the worst week since January.
Apple Inc., Exxon Mobil Corp. and Microsoft Corp., with the biggest weightings on the benchmark equity gauge, generate half or more of their revenue from markets outside the U.S., data compiled by Bloomberg show. Apple, which gets 56 percent of its sales from foreign sources in 2014, makes up 3.9 percent of the benchmark equity gauge, more than twice the weight of the next-largest component.
‘‘I’m not sure prices have factored in the effect’’ of the stronger dollar, John Carey, a Boston-based fund manager at Pioneer Investment Management, which oversees about $230 billion, said in a phone interview. ‘‘The market is worried about earnings as the first quarter comes to a close. I don’t know how much the market has fully realized how much earnings can fall.’’
The Bloomberg Dollar Spot Index gained 6 percent this year to 1,198.28 as of 2:32 p.m. in New York.
Companies will start to report first-quarter results in April, and quarterly profits are forecast to decline for the first time since 2009. S&P 500 results will see a contraction of 5.8 percent from the year-earlier period, according to economist estimates compiled by Bloomberg. Earnings growth forecasts were positive as recently as January, the data show.
To money managers including Kevin Divney of Beaconcrest Capital Management LLC, a stronger dollar is boosting the appeal of smaller companies that get a lower portion of sales from international sources.
As of January, the 30 companies in the Dow Jones Industrial Average derived about 45 percent of their sales from outside the U.S., on average, according to filings compiled by Bloomberg. That compared with 16.3 percent for those in the Russell 2000 Index.
‘‘One opportunistic trade here could be moving into companies that have less global exposure, for visibility and safety,’’ Divney, chief investment officer at Beaconcrest Capital Management, said in a March 26 phone interview. ‘‘That would advocate getting more into the small- and mid-cap stocks, which have been performing much better this year.’’
While the effect of the dollar’s appreciation has trickled down to the real economy, as seen in falling exports and slowing durable goods orders, growth is still ‘‘above trend’’ and the Fed remains on track to raise borrowing costs for the first time in almost a decade, Fed Chair Janet Yellen said on March 18. Higher rates drain liquidity from the financial market, decreasing the supply of dollars and making equities less attractive.
‘‘Our expectation is that the S&P 500 will struggle to make further headway over the next couple of years despite the health of the U.S. economy,’’ John Higgins, a senior markets economist at Capital Economics Ltd. in London, wrote in a research note on March 27. ‘‘The strengthening dollar and labor market at home will begin to squeeze profit margins.’’