S&P 500 May Be Vulnerable To A Pullback If The US Dollar Rebounds

S&P 500 Fundamental Forecast: Bearish

  • Stimulus hopes and vaccine developments pushed the US Dollar to a fresh 2.5-year low
  • A potential rebound in the US Dollar may hinder stock markets’ record rally
  • The S&P 500 index is trading at 28.7 times price-to-earnings (P/E) ratio, far above its 5-year average

The upward trajectory of US stocks appears to be underpinned by a weakening US Dollar, which has fallen to its lowest level seen since April 2018. The S&P 500 index has demonstrated strong negative correlation with the US Dollar index over the past 12 months, with a correlation coefficient of -0.80 (chart below). This is partly because over 40% of the revenue generated by the index’s constituents comes from overseas. A weaker US Dollar means that their overseas income will become more valuable when translating back to the home currency, supporting share prices.

Dollar’s weakness was primarily driven by renewed stimulus hopes as the US House speaker and Senate leaders agreed to support a bipartisan stimulus plan as the basis for a new round of negotiations. The bill appears to have received more support from the Republicans, raising prospects for a deal to be struck by end of the year.

S&P 500 Index vs. DXY US Dollar Index – 12 Months


Source: Bloomberg, DailyFX

On the flipside, however, traders should be vigilant about a potential rebound in the US Dollar (UUP) if the distribution of vaccines leads to a pickup in demand for goods and services (and thus inflation) and stronger fundamentals. The rollout of COVID-19 vaccines may allow people to gradually return to their normal spending patterns, leading to a surge in demand particularly for dinning, travel, retail and entertainment. This may point to higher pricing power in the months to come.

Besides, vaccines’ rollout may also shed reliance on future fiscal and monetary stimulus. This may potentially catalyze a rebound in the US Dollar.

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