The weakness in Europe and Asia has not just made the United States the strongest stock market in the world, but has increased demand for the U.S. dollar. While this may seem like a positive from a nationalistic point of view, it actually tends to be a negative for stocks.
Click to Enlarge Independent analyst Rennie Yang published a study over the weekend that shows this quite well. He observed that the 50-day correlation between the S&P 500 (NYSE:SPX) and the PowerShares Dollar Index (NYSE:UUP) reached a very high 80% last Thursday, the highest reading recorded since November-December of 2007. He notes that you generally don’t want to see the dollar and stocks moving in the same direction if you’re a market bull because since 2007 there have only been five other cases when the SPX-to-UUP 50-day correlation has hit 50%.
As you can see in his table above, four of the five led to significant selloffs by the time the 50-day correlation moved back into negative territory. Yang reports that the correlation has been over 50% since March 11 when the SPX was at 1556.
Click to Enlarge I received a subscriber question on this subject, so I will raise it right here: “What type of stocks should one be in if the dollar continues to show strength?”
The answer is that generally when the dollar rises in value, the cost of U.S. exports rises, making them less competitive. This tends to depress the value of commoditized industrial goods, and raw commodities in particular, as they are most easily replaced by cheaper goods sourced elsewhere. This is one of the reasons that steel makers such as AK Steel (NYSE:AKS), as well as U.S. Steel (NYSE:X) are having such a hard time this year. It also helps explain the troubles at chemical producers such as Dupont (NYSE:DD), at right.
So the answer is that it’s easier to say what to avoid than exactly what to buy. Avoid the commodity producers. The best bets in a strong dollar environment tend to be in health care, telecom and staples, and that is what we are seeing in the last few months already. I’ve shared a few options to take advantage of this trend in the Trade of the Day column recently, including are Boston Scientific (NYSE:BSX) and Sprint (NYSE:S).
Read on for more information on those trades:
InvestorPlace advisor Jon Markman operates the investment firm Markman Capital Insight. He also writes a daily swing trading newsletter, Trader’s Advantage which aims to capture profits of 15% to 40% and often as much at 100% to 200% in less than 90 days.
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