As we await the November U.S. non-farm-payrolls data tomorrow, the market is abuzz with European Central Bank chatter today. The decisions from "across the pond" are impacting the currency markets, which is a subject I've seen discussed more and more lately.
Where are the U.S. dollar and the euro headed, and what impact will they have on stocks? This feels like a long-term question that's getting a short-term answer.
You can clearly see short-term traders making decisions today about foreign exchange's perceived future impact on stocks. But what's ironic is that forex strikes in an unexpected manner when you consider the long-term correlations over the past seven years.
If we look at the SPDR S&P 500 ETF (SPY) vs. both the dollar and the euro (as represented by the PowerShares US Dollar Bullish ETF (UUP) and the CurrencyShares Euro ETF (FXE) respectively), the results might surprise you:
Over the longer term, equities have spent more time positively correlated to the euro than the dollar. But over the past 18 months, almost 90% of the SPY-to-FXE correlation has been negative.
While we see periods of strong correlation, the reversal to negative is often swift -- but not very telling about SPY's next directional move. The only clear takeaway from the above chart is how the euro and dollar move against each other predominantly over time.
But switch up the look to UUP and FXE vs. the Energy Select Sector SPDR (XLE) and you do find slightly more consistency:
There's better consistency in both the negative correlation to the dollar and a positive one to the euro. But the pattern isn't that much different from the SPY correlation, and I don't see any consistencies regarding XLE's performance relative to its correlation with either currency.
XLE has peaked when its correlation to the euro was low and bottomed when its correlation to the euro was high. This pattern is really no pattern, but can be seen many times in the chart above. That makes XLE's longer-term view based on these two currencies random.
As for the SPDR Gold Trust Shares (GLD), that appears to run in large extremes in its correlation to either currency. We often see either a very high positive correlation or a very high negative correlation:
That said, the positive correlation with the FXE is much more consistent than with the dollar. If I were going to base a longer-term play based on a few observations of the euro, it would done with one of the metals (silver or gold).
I still don't love this thesis, but I at least like it -- and I like it far more than equating SPY or XLE to FXE or UUP on any timeframe longer than maybe a month.
So, if you're bullish on the euro, you might want to give gold, silver or mining stocks a consideration.