The Commodities Connection | EQUITIES AND FOREX Part 4

The relationship between currencies and equities is an area of interest that is becoming increasingly evident and important for traders to become knowledgeable about.

For example, when the yen is weak, Sony’s and Canon’s share values become more attractive because they are exporters and, in effect, dollar earners. In all equity markets around the world, exporting sectors benefit from a weaker home currency or the expectation of one.

DaimlerChrysler, Renault, and Peugot suffer share declines when the euro surges beyond expectations. As we noted in our section on China (Chapter 4), when there is speculation that the renminbi will increase, many Chinese equities increase in stock value due to expectations that their assets will increase in value.

U.S. housing sector equities have a direct link to forex. For example, in December 2006, Black and Decker warned its shareholders that it faced “significant challenges” due to a slump in the housing market. The equity market sell-off on February 27, when the 38 WHAT DRIVES THE FOREX MARKET?

Dow Jones Industrial Index suffered its worst day in four years, was a direct example of the link between equities and forex. The sell-off was precipitated by a sudden fall in the dollar against the yen. This decline caused a liquidity crisis as hedge funds needed to sell equities to release funds to buy back their positions in the yen. (See Chapter 1 for a discussion of this event.) As globalization increases, strong currency moves will impact equity markets as it did on February 27. In a real sense, tracking equities where their dollar earnings are important can benefit a trader in providing leading indicators of forex price moves.

The relationship between the dollar and the equity markets is further underscored by the Dow Jones Industrial Index reaching historic highs. This occurred as the USDX entered into an extended downtrend (see Figure 5.5). Why has the relationship been inverse between the equity market and the value of the dollar? A deeper look reveals the answer. As the dollar value declines versus other currencies, the companies that export to the rest of the world benefit from increased sales, as exports become more attractive to foreign buyers. Additionally, multinational corporations having assets abroad experience an increase in the dollar value of those assets.

FIGURE 5.5 Dollar Index vs. the Dow.

Source: CQG, Inc. Copyright C  2006. All rights reserved worldwide.