December 3, 2014

What Does a Strong Dollar Mean for U.S. Stocks?

In recent months, the U.S. dollar’s exchange rate has appreciated by 5-10% against other major currencies. For U.S. consumers, the stronger dollar may be good news — it creates a beneficial “wealth effect” when spending abroad or buying imported goods.

However, for U.S. companies and their domestic employees, the effect may not be so beneficial:

  • U.S. exported goods and services tend to become less price-competitive to overseas buyers.
  • U.S. companies are incentivized to make international acquisitions and use foreign labor and materials.

What does it mean for U.S. stock returns going forward?

Reviewing the historical data, we do not see a consistent relationship between short-term fluctuations in the U.S. dollar and future U.S. stock returns.

However, we do see that long-term changes in the U.S. dollar exchange rate have had a historical relationship to future returns of the S&P 500 Index.  More specifically, the downward slope of the trend-line in the chart below shows that increases in the U.S. dollar over a trailing ten-year period have been associated (on average) with lower future S&P 500 Index returns over the subsequent four-year period.

While we don’t know whether this long-term historical relationship will continue in the future, we note that as of the time of this writing, the ten-year change in the U.S. dollar’s exchange rate has been about +0.7% annually. Taken in isolation, this would seem to imply a fairly tepid outlook for U.S. stocks over the next four years.

However, we advise against basing your market outlook exclusively on this or any single indicator. As we’ve seen in our April 11th and July 22nd blog posts, there are many factors that have the potential to impact future stock returns.