A major "headwind" after the NASDAQ's new high: strong US dollar

According to a report from Hong Kong Wind Information, on Monday, both the S&P 500 Index and the technology-heavy NASDAQ Composite Index reached all-time highs. However, analysts warn that investors should remain vigilant about the movement of the dollar, as historical data shows that a sustained strong dollar may constrain further gains in the stock market.

Currently, the dollar is undergoing a "temporary consolidation," with the ICE Dollar Index—measuring the dollar's exchange rate against six major currencies—expected to break its streak of eight consecutive weeks of gains. The index fell 1.6% last week, marking the largest weekly decline since August 23. Despite the pullback in the dollar index, it is still expected to rise 2% this month and has reached its highest point in the past year.

Previously, after Japan released strong inflation data, the yen appreciated significantly against the dollar, leading the market to anticipate that the Bank of Japan might raise interest rates, which also contributed to the dollar index's decline.

The strength of the dollar was once supported by U.S. economic data and rising U.S. Treasury yields, especially under the expectation that future U.S. government policies and fiscal plans could bring inflationary pressures, allowing the dollar to continue its ascent. This trend also reflects market expectations that these policies will drive U.S. economic growth, keeping it ahead of other economies.

Analysts Veneta Dimitrova and London Stockton from Ned Davis Research (NDR) noted that a strong dollar is generally beneficial for the economy. It typically means lower oil prices and other commodity prices, leading to deflation; at the same time, it tends to lower inflation expectations and boost consumer confidence. Additionally, a strong dollar attracts foreign investment, aiding capital expenditure and supporting the U.S. Treasury in financing the government's growing debt.

So far, the strength of the dollar has not posed significant resistance to the stock market's rise. The S&P 500 Index and the Dow Jones Industrial Average continue to set new records, with the S&P 500 Index rising over 26% year-to-date in 2024.

However, this is not all good news: the appreciation of the dollar makes U.S. export products more expensive for foreign buyers, which could impact corporate profits. Furthermore, a strong dollar may also widen the trade deficit, thereby dragging down economic growth. NDR analysts pointed out that although foreign profits account for a small proportion of overall corporate profits, they are still significant. Currently, profits from overseas have dropped from over 20% before the pandemic to about 12% now.

Analysts stated, "While this proportion may seem negligible, a strong dollar could still negatively impact corporate profits and stock prices." This negative impact on stock prices may lead companies to take measures such as layoffs, further dragging down the economy.

Additionally, the one-year rolling correlation between the dollar and the S&P 500 Index is approximately -0.4. A correlation of -1.0 means the two move in completely opposite directions, while a correlation of +1.0 means they move in complete sync. A correlation of 0 indicates no statistical relationship between the two.

Analysts pointed out, "In fact, the negative correlation between the dollar and the S&P 500 Index suggests that a strong dollar may become a headwind for the stock market." Source: wind