Strengthening Dollar Historically Hints at Pause in Equity Markets

Below is a chart and brief excerpt from today’s Market Situation Report written by Tier 1 Alpha. If you’re interested in learning more about the Hedgeye-Tier 1 Alpha partnership, there’s more information here.

Today's bonus chart focuses on the DXY, also known as the Dollar Index. The Euro constitutes 57.6% of the DXY's composition, followed by the Yen at 13.6%, and the Pound at 11.9%, with the Canadian dollar, Swedish krona, and Swiss franc completing the mix. We're witnessing an era of unprecedented concentration within the S&P 500, with the "Magnificent 7" increasingly gobbling up market cap. The international nature of these companies has increasingly turned the DXY into an SPX proxy.

The current 90-day correlation coefficient between the DXY and S&P 500 performance is -0.95, a strong negative correlation. As market indices have retreated, the dollar has notably strengthened, aligning with the usual market dynamics amid uncertainty or pessimistic sentiment. Conversely, as markets hit new highs, the dollar tends to weaken.

This correlation can be weaponized as a leading indicator for broader market trends. With the Euro and Pound marking a succession of daily higher lows and higher highs, dollar weakness is typically favorable for the S&P 500. Historical patterns show that some of the dollar's best performances occur when year-over-year GDP decelerates by -1% or more. Currently, the dollar's trajectory isn't signaling immediate threats to the stock market. However, if the dollar begins a broad appreciation while GDP contracts, it could be a compelling sign that a pause in equity market growth is on the horizon.

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