O Dollar, Where Art Thou? New Update
By Chris Turner
March 14, 2012
Given the precipitous rise of the S&P 500 Index in the last few months, I thought it would be interesting to update the November chart showing the value-adjusted S&P 500 to the dollar index. See my November 8th commentary O Dollar, Where Art Thou?
Using the Trade Weighted US Dollar data available from the Federal Reserve's Economic Data Repository (FRED), we see the dollar continues a downward trend.
The original justification for the study consisted of "what would the S&P 500 Index look like if we adjusted for the rise or fall of the dollar?" Rather than adjust the Index for inflation from BLS, we simply adjust the Index based upon where the dollar trades against the basket of foreign currencies. The updated chart below shows the dollar index, the S&P 500, and the dollar-adjusted S&P.
Since November, the S&P Index gained strength while the dollar began to roll over. When adjusting for the lower dollar, the current S&P 500 Index would be just shy of 1000 at 989. Note the impact of a stable dollar (roughly 100) during the peak in 2000 and the substantial difference now with a weaker dollar. Based on this study, the dollar would have to fall 14% to 62 to reach the previous peak of 1565 (14% higher from current S&P 500 at 1370).
Continuing our updates, the next chart displays the dollar index, reported earnings (trailing 12 months), and the equivalent earnings if adjusted for the currency movements.
Earnings have topped the 2007 high nominally, but when adjusting for the lower dollar, the adjusted earnings have not reached the same peak. The following chart is new to the series. Readers may wonder how our current dollar trades if viewed in a normal ebb and flow. When considering that US administrations change policies that affect our dollar, the dollar index can be viewed as a metric that measures the success or failure of those changes. To graph this, I simply provided the "spread" from 100, both above and below, to show the net result of administration policies.
The red line shows the median of the dollar index since 1973. Above 9.8%, the spread represents when the dollar was above (strong dollar) or below (weak dollar) the normal range. I placed some numbers to provide context, not exact reasons for why the spread was so large during each of these periods.
- Time period after inflation-breaker Volcker. Dollar extremely strong? Or other currencies very week?
- Time period following US recession. Dollar weak due to government stimulus? Or other currencies really strong?
- Currently dollar very weak. Due to egregiously low rates and rampant government spending? Or other countries have better fiscal situations?
Regardless of one's view, the net result is that our dollar is weak compared to a basket of currencies. Inflating or deflating the S&P 500 by the dollar's value is a thought exercise meant to show how much our dollar value changes the perspective of the index if the dollar went back to 100. This chart series simply reflects the currency risk of a strong dollar and the net impact to the S&P 500 Index and earnings if the dollar rises to parity.