Courtesy of Doug Short.
Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
Most of us who follow economic data as a hobby understand that incomes have remained flat over the last decade when adjusted for inflation. As Doug Short points out, ”The stunning reality illustrated here is that the real median household income series spent most of the first nine years of the 21st century struggling slightly below its purchasing power at the turn of the century.” Knowing when inflation rises, we know purchasing power declines in dollar terms. But what happens on a global basis when our dollar declines? Our “dollar” purchasing power declines globally and buys fewer goods.
Many causes exist to reduce our global purchasing power; monetary policy and governmental fiscal health to name a few. Using the Trade Weighted US Dollar data available from the Federal Reserve’s Economic Data Repository (FRED TWEXMMTH), we can see the impact of the U.S. monetary policy when comparing our Dollar’s purchasing power related to global currencies.
Notably, the U.S. Dollar remains near the bottom and has steadily declined since the peak in the mid-80’s. The local impact on U.S. consumers would be that all imports get more expensive when the dollar sinks. This article isn’t about to explain how bad our government finances are related to the world, rather, the goal is to show the relationship of the Dollar and impact on our “local” broad market measure, the S&P 500 Index.
The original justification for this study was my article that asked the question “what would the S&P 500 Index look like if we adjusted for the rise or fall of the dollar?” Rather than adjust the Index for inflation from BLS, we simply adjust the Index based upon where the dollar trades against the basket of foreign currencies.
The first chart in the series shows the first layer in the study – the data that originated from FRED.
The next chart displays the S&P 500 Index in red and a “dollar-adjusted” index in blue with the previous dollar chart in the background.
Much can be gleaned from this chart. First, note that the S&P 500 and the dollar index both climbed in the late 90’s – the last time we had a “surplus” rather than an annual deficit. Next, note that if adjusting the S&P 500 by the dollar, we are just now at parity with the S&P 500 in 2000.
Continuing our updates, the next chart displays the dollar index, reported earnings (trailing 12 months), and the equivalent earnings if adjusted for the currency movements.
Earnings have topped the 2007 high both nominally and including an adjustment for the dollar devaluation.
The last chart shows the percent difference between the actual S&P 500 Index to the dollar-adjusted index.
Using only positive numbers, the “spread” or difference between the adjusted S&P 500 and the actual S&P 500 correlate the historical context of where we are relative to other time periods. The red line shows the average of spreads from 1973 through each successive time period – which is just around 12% as of today. Think of the distance away from the average similar to mean reversion – at some point, the dollar will strengthen and revert toward 100.
Regardless of one’s view, the net result is that our dollar is weak compared to a basket of currencies. Inflating or deflating the S&P 500 by the dollar’s value is a thought exercise meant to show how much our dollar value changes the perspective of the index if the dollar went back to 100. This chart series simply reflects the currency risk of a strong dollar and the net impact to the S&P 500 Index and earnings if the dollar rises to parity.
