Dollar's Link to Stock Prices
Puzzles Some Money Managers

By MICHAEL R. SESIT and SUZANNE MCGEE
Staff Reporters of THE WALL STREET JOURNAL

Foreign interest in U.S. stocks is being reflected in an unusual link between Wall Street and the dollar, and that's confusing some money managers.

Simply put, as the U.S. stock market rises, the dollar climbs along with it -- especially against the mark and other European currencies. And when Wall Street retreats, so does the greenback.

"It's quite rare to see this kind of significant positive correlation," says Ray Dalio, president and chief investment officer at Bridgewater Associates Inc., a Wilton, Conn., firm that manages more than $8 billion in currencies and global bonds. "Typically, this isn't a straightforward linkage, but now we're seeing the direction of the stock market having a big potential and actual impact on the dollar."

Many markets tend to move in tandem, including the U.S. stock and bond markets. And this isn't the first time the dollar has marched up and down alongside another U.S. financial market. In 1994, for example, the dollar closely paralleled the moves of the U.S. Treasury market.

But the more recent dollar-Wall Street correlation has intrigued money managers and analysts. From the end of last year to Aug. 6, the Dow Jones Industrial Average rose 28% to a record while the dollar climbed 23% against the mark. Since then, U.S. stocks have fallen 4.1%, the dollar 5.7%.

To explain the pattern, analysts point to the capital flows into the U.S. As European and Asian economies remain sluggish or downright troubled, says Michael Burke, a London-based economist for Citibank, the American "economic miracle" looms in stark contrast, luring many overseas investors into dollar-denominated assets, such as stocks and bonds. Technological change, soaring productivity and the impact of huge corporate restructuring moves are convincing more foreign investors that they should buy stocks in the companies benefiting from these initiatives.

To many, the growing correlation between the dollar and U.S. stocks also reflects the expansion of world trade, increasing cross-border stock investment and the growing transparency of global stock markets.

As corporations buy and sell more internationally, "there's no question companies must be more currency-sensitive," says Michael Hintze, a managing director at Credit Suisse First Boston in London. "And if their underlying business is more currency-sensitive, it follows that the capital markets must be more currency-sensitive."

The tighter link between U.S. stock prices and the dollar is an aberration that says nothing about the market, some contend. But Avinash Persaud, head of currency research at J.P. Morgan & Co. in London, notes that bond investors have long recognized the importance of crossborder capital flows in valuing fixed-income markets. Now, he says, "The increasing role played by international investors in equity markets could alter the valuations in those markets."

Mr. Dalio's concerns are more immediate. "What you see from this pattern is that international investors are now more volatile and more sensitive to the health of the U.S. economy," says the Bridgewater Associates executive. "There's the perception that if they feel it's grown too risky to be in stocks, they'll pull out, and that will send the dollar down as well."

Mixed with a dose of nervousness about corporate earnings, the dollar-stock market connection certainly has its downside, particularly as a growing proportion of U.S. company profits come from abroad. Katherine Jenkins, a portfolio manager at Hill Samuel Asset Management in London, notes how U.S. shares fell after Coca-Cola Co. and Gillette Co. reported lower-than-expected earnings because of currency fluctuations.

The increasing volatility of both U.S. stocks and the dollar is already making overseas investors jumpy.

"The dollar is quite volatile, and that means your [investment] return is much more volatile," says Hans Peters, a strategist at Fortis Investments in Utrecht, the Netherlands. Still, not everyone is a believer in tracking the dollar/stock link. "It's just something people latch onto," says Mr. Hintze of Credit Suisse First Boston. "It's a theme that's taken people's imagination."

Even Mr. Burke of Citibank concedes that the dollar-Wall Street correlation may be strengthening because "a lot of investors are monitoring it, rather than any fundamental link between the two." Mr. Peters of Fortis believes the dollar-stock link is "a temporary thing." He sees the greenback falling as European growth picks up and the interest-rate differential between 10-year German and U.S. government bonds narrows. "The dollar will decline regardless of what the stock market does," he says.