Ned Davis Research analysts warned in a report last Friday that stock market investors need to closely monitor the dollar's movement, as history shows that a persistently strong dollar may hinder further gains in the stock market.

Currently, the strong dollar seems to be taking a breather, ending an eight-week streak of gains. The dollar has been rising throughout the fall due to soaring U.S. Treasury yields, reflecting strong economic data and concerns that the incoming Trump administration's trade agenda and fiscal plans may exacerbate inflation worries, thereby limiting the Federal Reserve's ability to further cut interest rates. The dollar's rise also reflects market expectations that these policies will boost the economy, allowing the U.S. to continue outperforming other countries.

NDR strategist Veneta Dimitrova and London Stockton point out that a stronger dollar is beneficial for the economy, which typically means lower oil and other commodity prices, having a disinflationary effect, and often reducing inflation expectations, boosting consumer confidence, and acting as a 'magnet' for foreign investment. This supports capital expenditure and helps the U.S. Treasury finance its growing government debt.

Meanwhile, the rise of the dollar does not seem to have significantly impeded the stock market rebound, with the S&P 500 and Dow Jones Industrial Average continuing to reach new highs. The S&P 500 has risen over 26% so far in 2024.

However, this is not all good news; a stronger dollar makes U.S. export goods more expensive for foreign buyers, which could hurt corporate profits. Analysts point out that this could also widen the trade deficit and suppress economic growth.

NDR analysts noted that profits from abroad account for a small proportion of overall U.S. corporate profits but are still significant, with foreign profits dropping from over 20% before the pandemic to about 12% now.

They wrote, 'While this may seem like a trivial proportion, a stronger dollar could still have a negative impact on earnings and stock prices.' They indicated that this negative impact on stock prices could also lead to corporate layoffs, thereby slowing economic growth.

Meanwhile, the one-year rolling correlation between the dollar trade-weighted index and the S&P 500 index is about -0.4. A correlation of -1.0 means the two assets move in completely opposite directions, while a correlation of +1.0 means they move in perfect synchrony; zero correlation means there is no relationship in the movements of the two assets.

They stated, 'In fact, the negative correlation between the dollar and the S&P 500 index indicates that a stronger dollar may pose a resistance to the stock market.'

Article reposted from: Jin Shi Data