The Dollar During Big Declines in Equities

October 1, 2014

In periods when U.S. share prices lose extensive value, the dollar tends to swing sharply as well.  In the past, the U.S. currency has experienced periods of both strength and weakness, and one does not find a pattern between the length of the bear market in equities and the direction of the dollar.

These conclusions emerged from an examination of eight bear markets in the Dow Jones Industrials over the past four decades.  A span of time, however long, in which share prices fall at least 10% but less than 20% is called a correction.  A downward run of at least 20%  escalates to bear market status. 

Many investors have been anticipating a correction soon because several years have elapsed since the last one, but far fewer analysts believe in the imminence of a bear market because U.S. economic fundamentals remain sound.  Low inflation and expected inflation means the Fed will transition only slowly in the coming normalization.  Growth in GDP and jobs has quickened.  Exports are competitive.  America has been called the Saudi Arabia of natural gas.  U.S. technology start-ups are busting out all over.  The budget deficit has fallen more quickly than imagined, and the current account deficit is contained at sustainable levels.  The U.S. has better demographic trends than other advanced economies.  Slower Chinese growth diminishes concern about the U.S. being overtaken in economic power anytime soon.  The outlook for corporate profits remains promising, and price/earnings ratios do no appear excessive.

As if on cue, U.S. share prices fell on this first day of the fourth quarter, so a look back at how the dollar performed in previous bear market episodes seems timely.

From September 21, 1976 through February 28, 1978, a span of 525 days, the DOW fell 26.9%, and the dollar dropped by 14.6% against the German mark.  This was a period of lively U.S. economic growth, a widening trade deficit, and accelerating inflation.  The Carter Administration carried image problems that were underscored by the difficulty of fashioning an energy policy even though the Democrats controlled Congress.  The Iran hostage crisis hadn’t begun yet.

From April 27, 1981 through August 12, 1982, an interval lasting 472 days, the DOW fell 24.1%, and the dollar climbed 15.7% against the mark and 22.3% versus the yen.  The end of this period signaled the last gasp of two decades in which the market went nowhere on balance.  The DOW was at 735 in mid-December 1961 and at 777 on August 12, 1982.  The U.S. economy suffered through a severe recession in this period, which was necessary medicine to turn the tide on inflation.  The dollar continued to climb, albeit with some interruptions, for 2-1/2 years beyond this period.

The shortest of the seven bear markets occurred between August 25, 1987 and October 19, 1987.  Although just 55 days in length, the DOW plunged 36.1%, including 22.6% on the final day.  The 30-year bond yield had soared in 1987, briefly reaching double digits, and the Louvre Accord in February 1987 to stop dollar depreciation was an important policy factor behind the year’s instability in all sorts of financial markets.  This bear market was not associated with a U.S. recession.  U.S. fundamentals were still behaving pretty well.  In the 55 days when the 36% drop in U.S. share prices occurred, the dollar was unchanged against the yen and off just 2.5% versus the mark.  But if one measures the dollar from August 25, 1987 to the end of that year, one finds dollar declines of 14.8% versus the yen and 13.4% versus the mark.

The bear market of July 16 – October 11, 1990 lasted 87 days and was associated with Iraq’s invasion of Kuwait and a spike in oil prices.  A comparative short and mild U.S. recession began in July 1990, so worries about growth as well as inflation were around.  The dollar fell by 7.5% against the mark and 12.0% relative to the yen during this 87-day bear market that saw the DOW lose 21.2%.

A span of 17 years during which the DOW climbed roughly 17% per annum ended in January 2000.  Over 616 days between January 14, 2000 and September 21, 2001, the DOW plunged 29.7%, and the last half year of this fall coincided with a  U.S. economic recession that ended two months after the DOW bottomed out.  The bear market ironically stopped when markets reopened following the World Trade Center attacks.  During the 616 days while the DOW was falling so much, the dollar in contrast appreciated by 10.9% against the euro and 10.0% versus the yen.

Over 126 days from March 19, 2002 through July 23, 2002, the DOW fell by 27.6%, and the dollar experienced declines of 11.0% against the euro and 10.6% versus the yen.  U.S. GDP was recovering but not fast enough to prevent a net 144K further drop in nonfarm payroll employment. 

The sharpest cumulative decline in U.S. equities of the seven bear market here examined was a 53.8% plunge between October 9, 2007 and March 9, 2009.  It was juxtaposed against the Great Recession, which for the United States lasted from December 2007 until June 2009.  In the six earlier recessions, the dollar had moved in the same direction against both the yen and the major European currency.  But this time, the dollar climbed 11.7% against the euro while dropping 15.6% relative to the yen. 

The sole consistent truth to hold up in all these examples is that when U.S. equities suffer a significant cumulating drop, the dollar also moves extensively in a trending way.

Copyright 2014, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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