Last week's surge in the dollar has some analysts calling for a correction in the stock market, but don't count on it.
The greenback has jumped sharply recently as short players were forced to unwind bets after French President Jacques Chirac called for "stability" in exchange rates and a Japanese finance minister said his country won't tolerate a stronger yen. Japan, which raised its terrorism alert Friday, sold a record 7.15 trillion yen in January in an effort to protect its exports.
Because a rally in the stock market over the past year has coincided with a falling dollar, some analysts worry that the recent strength could put pressure on the market.
"Check your charts, the U.S. stock market has loved the weak dollar, so just maybe this is going to be the reason, or part of the reason, for the four-month sabbatical I've been predicting for this powerful bull market," noted Don Hays, president of Hays Advisory.
Last year, the
rose 26% while the dollar fell 17% against the euro and more than 9% against the Japanese yen. So far this year, the dollar is down another 1% against a basket of currencies and the S&P is up 3%.
Analysts say investors are happy that the soft dollar is boosting corporate earnings, and some pundits believe the slide has attracted foreign inflows because U.S. assets are suddenly a lot cheaper to buy. Net foreign purchases of U.S. assets came in at $75.7 billion in December, and totaled $708.7 billion for 2003.
Still, some analysts say a near-term reversal in the dollar won't hurt stocks because long-term expectations for dollar weakness haven't changed.
"Absent a change in the fundamental conditions driving the dollar lower, namely, a too-easy Fed, the dollar's most likely course points to further weakness," said David Gitlitz, chief economist at Trend Macrolytics.
Even if the dollar is in the early stages of a recovery, however, that doesn't mean the stock market is about to pull back.
Although a depreciating dollar can be beneficial for stocks, it definitely has its drawbacks.
A big concern over the past year has been that foreigners could take money out of U.S. assets, particularly if they believe the dollar is going to slide further, because their current holdings will be worth less when converted back into local currency.
If the greenback were to bounce back, some say it actually would bode well for stocks because it would suggest growing confidence in the U.S. economy. During the late 1990s, the market advanced sharply while the dollar was rallying against other major currencies.
Gibbons Burke, editor of Markethistory.com, doesn't believe that currency moves determine the direction of stocks. Instead, he believes equities actually influence the foreign-exchange market.
"By my reckoning, it appears to me that the returns on the SPX tend to lead that of the dollar," he said.
Back in December, Burke said "recent bullishness in the market, as shown by the relatively big move in 12-month returns in stock prices, would imply that eventually, and sooner than later, it should put the brakes on the dollar's slide."
Still, David Parsley, a professor at Vanderbilt's Owen Graduate School of Management, said it's simply too hard to predict what will happen in the currency market based on what is transpiring in the securities market, or vice versa.
He noted that some events, like a
interest rate hike, can be very bullish for the dollar but bearish for stocks, and said the positive and negative effects of an appreciating or depreciating dollar often cancel each other out.
"If there was a predictable relationship," he said, "then some smart finance guy would be able to arbitrage that relationship, so it would drive it away."
While the stock market could decline for other reasons over the near term, perhaps because valuations in some sectors are too high or because expectations for a rate hike go up, a change in the value of the dollar is less likely to be the catalyst for any reversal, said Michael Bernstein, professor at the University of California in San Diego.
"The Fed is saying it will keep rates right where they are, but how long can that go on? That might account for some people fleeing," he said.