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Stock Market and the Dollar: There are only 3 possibilities

With stocks and the dollar on a see-saw, there are only three possibilities to choose from.

Since the stock market is in the news (perhaps as a result of trillions of dollars/euros/yen/yuan/quatloos having suddenly vanished from millions of accounts), it seems timely to examine the key correlation between stocks and the U.S. dollar. As I have often noted here, this “big picture” correlation is a simple see-saw: when the dollar is scraping bottom, stocks are at their highs, and when the dollar is up then stocks are tanking.

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At the risk of alienating chart-averse readers, I’ve marked up the charts of the S&P 500 (SPX) and the U.S. dollar index (DXY).

For those who aren’t going to look at the charts, what they suggest is that there are really only three possibilities in play:

A. Stocks go up and the dollar drops to new lows

B. Stocks fall and the dollar rises significantly, a pattern that has repeated several times since 2007

C. The see-saw breaks and stocks and the USD rise or fall together.

The key to the relationship between stock valuations and the dollar is corporate profits. When the dollar declines, then U.S. global corporations’ overseas earnings–now roughly 60% of total profits for many big global corporations–expand as if by magic when stated in dollars.

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