Can the U.S. S&P 500 remain resilient if the dollar strengthens further?
T he euro’s behavior is a major threat to U.S. financial markets. The euro and U.S. stocks are still positively correlated, so a large fall in the euro is genuinely negative for stocks. However, it is also true that the correlation between stocks and the euro has been lessening in recent months. The euro has fallen about 15% since April 2011, while the S&P 500 has actually moved down less than 4%.
According to our Global Investment Strategy service, the U.S. stock market would be resilient at levels above EUR/USD 1.20. But if the euro plunges to substantially lower levels, creating a surge in the U.S. dollar, it could lead to profit contraction in the corporate sector, especially if bond yields and/or oil prices can not act as a relief valve. So far, the euro’s depreciation has been orderly and the German economy has been strong, which has been a key supportive force behind the euro. Still, with French legislative elections and Greek general elections in mid-June, the euro is at risk of violent swings.
Our base case is that the S&P 500 should weather a further decline in the euro. However, a severe drop in the euro would be a harbinger for a much more severe outcome.