Understand economic data correlation.
Avoid bias when analyzing market trends.
Learn to interpret financial relationships.
Investing
Zoe Team
2 min read
What does this article teach about data?
It warns that economic and market data can be manipulated to support almost any pre-existing belief or bias.
What is the relationship between the dollar and stocks?
The article uses the analogy of ‘sibling dynamics’ to explore the complex and often misinterpreted relationship between them.
How should one view market data?
One should remain skeptical, as data can be squeezed to tell whatever story the observer wants to see.
One of the few things that I learned after thousands of hours analyzing economic and market data, is that you can find a way to squeeze the data to tell you whatever you want it to tell you. For instance, if I was a firm believer that watching Nicolas Cage movies was detrimental to human beings, I could sift through millions of different safety data points to find a very strong relationship between the number of people who drowned by falling into a swimming pool, and the number of films Nick Cage appeared in. Ahh, there it is! I knew it, Nick Cage’s movies are dangerous to our children.
No. of people drowned in a pool per year vs. No. of Nicolas Cage films per year
I have recently seen a few headlines like “US stocks fall as dollar climbs” or “US stocks rise as dollar falls” insinuating that there is a strong negative relationship between the U.S. dollar and the U.S. stock market. Those types of headlines are good for a slow day, but the reality is that U.S. stocks and the dollar have a relationship like most young siblings. I grew up with two brothers. One minute we were best friends and the next my dad had to stop us from hurting each other! I am going to put a picture from the movie Step Brothers below… no explanation needed for those that have seen the film. (Should have been nominated for an Oscar in my humble opinion.)
Don’t believe me? Check out the chart below. What it shows you is the correlation (or relationship) between the S&P 500 and the U.S. dollar (measured vs. a basket of other currencies) for the past 18 months. Correlations run from -1 to 1. The more negative the relationship the closer it gets to -1, while the more positive the relationship, the closer it gets to 1. Ehhh… the blue line is not very steady, right? Kinda fluctuates.
Relationship between the US dollar and S&P 500 over 18 months Source: Thompson Reuters, Federal Reserve
You might say, well what about longer periods of history? Check out the chart below which looks at 40 years worth of data. The only pattern is that the relationship is hot and cold. In some years stocks and the dollar move in the same direction, in others, they move in separate directions, and in some years they just kinda have no relationship at all.
Relationship between US dollar and S&P500 over 40 years Source: Thompson Reuters, Federal Reserve
So what is the lesson here? In statistical lingo: Dollar movements do not drive stock prices, or short-term correlation does not equate to causality. In plain language, just because your brother put you in a choke hold today it does not mean he won’t be your best friend tomorrow.
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