How The Fed's Strong Dollar Made Further Market Gains Impossible: JPM Explains

In recent months, much has been said about how as a result of the rising correlation between oil and equities (and pretty much all other asset classes), crude has been dragging down stocks, and alternatively unelashing furious short squeezes on even the tiniest pop in the price of oil.

But what about the impact of the strong dollar on the S&P 500?

We have some bad news for the bulls, courtesy of JPM's Kolanovic, who explains how the strong USD is now both a blessing and a curse for equities. But mostly a curse in that the market can't rally without a stronger dollar... and that it also needs a weaker dollar to rally.

S&P 500 and USD: In our previous report, we explained our view that the market may stop rewarding passive investors (who were winners in recent years). In that light, we are not excited about owning the S&P 500 as core exposure to risky assets. The S&P 500 is capitalization weighted, has high momentum bias, is internet heavy, and is implicitly long USD (when the USD is near historical highs). The current correlation of the S&P 500 to USD is ~30%. One of the reasons behind the positive correlation of the S&P 500 to USD is the high weight in Momentum and Low Volatility stocks in the index, and these stocks’ positive correlation to USD. At the same time, the index has low weight in Value stocks that are negatively correlated to USD (correlation of momentum, value and S&P 500 to USD are shown in Figure 1). When it comes to macro drivers of equities, the S&P 500 may be trapped by USD: it can’t rally to new highs without USD (momentum sectors, FANGs, etc.), and at the same time the strong USD is capping any significant upside due to its negative impact on EPS (via value segments such as multinationals and energy).


Summary: the market is now damned if the Fed hikes more, and damned if it doesn't.