Trading The Dollar/Stocks Correlation Is Complete Bunk

This should throw some cold water on the ‘weak dollar explains the market’ camp. This includes even many professional traders, who frequently just sort of adopt market memes and start repeating, with short memories and a lack of investigative effort. As long as they’re making money, and it seems to be due to their skill, then nobody complains.Yet here is a long-term correlation between the U.S. dollar and stocks, from Morgan Stanley.

Actually, stocks have usually rallied while the U.S. dollar was strengthening. More importantly, it’s clear that overall the correlation reverses pretty often, and suddenly. Thus the dollar seems pretty undependable as a signal for stocks. It looks pretty right for a bit… and then it’s completely wrong.

Morgan Stanley: First, there is now a tight inverse correlation between the dollar and equity markets. This is unusual: Exhibit 2 shows that equity markets and the dollar usually are positively correlated (so dollar strength goes hand-in-hand with rising equities). Consequently, this correlation could weaken if the dollar strengthens because US growth and rates are expected to rise.
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(Via Morgan Stanley, ‘Dollar: Ouch’, Gerard Minack, 9 December 2009)

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