Stocks, Dollar in Rare Sync

Mirror-Image Moves, Historically Unusual, Come as Markets Await Fed’s Plan

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“…upon the earth distressStrongs 4928: sunoche, soon-okh-ay´; from 4912; restraint, i.e. (figuratively) anxiety: — anguish, distress. of nations, with perplexityStrongs 640: aporia, ap-or-ee´-a; from the same as 639; a (state of) quandary:—perplexity.
Strongs 639: aporeo, ap-or-eh´-o; from a compound of 1 (as a negative particle) and the base of 4198; to have no way out, i.e. be at a loss (mentally):— (stand in) doubt, be perplexed
—Luke 21:25

The latest mantra on Wall Street: stocks up, dollar down.

Historically, moves by stocks and the currency have tended to show no relationship.

But since the stock market bottomed in July and the Federal Reserve started leaning toward policies that have pushed down the dollar, the two asset classes have been moving against each other, raising eyebrows among many analysts and investors.

Joseph Mezrich, a quantitative research analyst at Nomura Securities, calls the trend “astonishing” and says he hasn’t seen such a strong relationship, or correlation, between stocks and the dollar since Richard Nixon took the dollar off the gold standard in 1971.

“It’s pretty remarkable,” Mr. Mezrich said. “One of the things that’s really bothered equity investors is that everything is moving together.”

According to his calculations, the correlation between the two asset classes has been negative 0.60 over the past four months, compared to a long-term correlation of positive 0.04—an essentially flat reading that denotes a near-absence of synchronicity. A correlation of positive 1.0 means assets are moving in perfect lockstep, while a correlation of negative 1.0 means they are going in exactly opposite directions.

The dollar and stocks have become increasingly correlated since the financial crisis, as central-bank monetary policies, worries about Europe’s debt woes or China’s economy dominate investors’ attention. But the connection right now is so stark that it is drawing more scrutiny.

Art Cashin, director of floor trading at UBS AG, laments that he’s spent years figuring out the markets, but none of his accumulated wisdom matters right now.

“After decades of honing skills of interpreting the likes of geopolitical events, economic data, and technical levels, things were reduced to a single item,” the dollar, Mr. Cashin wrote in a note last week. “Not much of an intellectual challenge there.”

While there is debate about who is leading who, there is little doubt that stocks and the dollar are responding to the same influence: the Federal Reserve.

The dollar has been falling, and stocks rising, as investors prepare for a round of stimulus measures by the Fed, expected to be announced after a meeting of policy makers next week.

Concerns about dollar dilution, and the longer-term prospects of inflation, have pushed the dollar down 6.9% against a basket of six currencies since Aug. 27, when Fed Chairman Ben Bernanke first signaled plans to engage in a new round of so-called quantitative easing in which the central bank buys U.S. assets. At the same time, the Standard & Poor’s 500-stock index has surged 13.1%.

Last week, the dollar declined slightly, while stocks were slightly up.

The U.S. Dollar Index closed the week at 77.18, near its lowest point of the year, and the S&P 500 ended at 1183.26, not far from its highest point of 2010.

The falling dollar can be good for stocks because it pumps up commodity prices—lending a boost to U.S. companies in the industrials, energy and materials sector, which have grown in importance on the stock market in recent years. A lower dollar is also good for exporting companies.

The relationship is especially in focus as investors gear up for what could be a volatile week of trading next week: Tuesday brings the midterm U.S. congressional election; on Wednesday the Fed is expected to announce its easing plans; Friday will see the release of the closely watched monthly U.S. nonfarm-payrolls report.

Many investors and market watchers say the relationship can’t last, and that stocks and the dollar, which historically haven’t taken many of their cues from one another, will soon separate.

How and when that happens likely depends on investors’ reactions to the Fed’s steps.

Another scenario is that better economic data boosts stocks while allowing the Fed to take a modest approach to quantitative easing. That could keep the equity rally rolling and enable the dollar to rise.

“You’d like to see a scenario where there are positive signs in the economy, so the dollar strengthens and stocks rally as well,” said Mikel Keifer, investment strategist at Jurika, Mills & Keifer.

But if the Fed’s asset-buying continues to drive down the dollar, helping exporters, trading partners may become increasingly aggravated and start employing protectionist policies—a negative for U.S. companies and their stocks.

In that case, the dollar and stocks could fall together.

“If you go down that path of a weaker dollar, eventually there’s a higher policy risk, with all these protectionist ideas being floated out there,” said Jim Dunigan, managing executive of investments at PNC Wealth Management.

Burt White, Boston-based chief investment officer for LPL Financial, cautioned that, even if the Fed’s policies hurt the dollar, stock investors may find themselves unimpressed by the impact.

Stock investors could ask, “Where’s the impact? You’ve put the gas on the fire, but where’s the smoke?” Mr. White said.

It also is possible that all traces of correlation—positive or negative—could simply dissolve after the Fed’s announcement on Wednesday.

“I’m expecting many of these relationships to shift once we see the numbers behind quantitative easing,” said Michael O’Rourke, strategist at BTIG, arguing that the Fed’s slow march towards quantitative easing has distorted the markets.

Mr. O’Rourke said that fundamentals, such as the dollar’s continued status as the world’s reserve currency, will eventually support a generally stronger dollar.

—World Value of the Dollar, B15

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