Thursday, March 12, 2015

How the U.S. Dollar Rise is Impacting the Stock Market

We have the unusual situation in which many central banks--most notably in Japan and Europe--are pursuing monetary policies of quantitative easing, while the U.S. has been in the mode of exiting its program.  The result is that interest rate differential trends across the world--as well as relative economic growth--increasingly support the U.S. dollar.  Indeed, as we can see from the top chart, the dollar index has been on an upward tear since mid February.

How is this impacting stocks?

We can see a meaningful correction among large cap shares in the second chart, the Major Market Index (XMI).  Note the smaller correction among small cap shares in the third chart, the S&P 600 Small Cap Index.  The larger companies that depend upon overseas sales become more vulnerable during dollar rises, as their prices become particularly expensive to those overseas buyers.  Smaller companies that produce and sell domestically--and especially those that import from overseas--are less impacted by the rising dollar and benefit from domestic growth.

Finally in the bottom chart, notice that sectors have performed very differently over the last few months (chart is from Finviz).  Utility shares have been particularly hard hit, given the drop in the large cap indexes but also the rise in interest rates in the past couple of months, as investors anticipate a normalization of rate policy from the Fed.  

The bottom line is that central bank dynamics are creating relative winners and losers among stocks, rather than the relentless upward trajectory we've seen over recent years.  This is true across market cap indexes and sectors, but also across the share indexes of regions of the world.   

Further Reading:  Sector Correlations and Their Importance