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Research:
DJIA-Dollar relationship...
Nasdaq also matters

6th February,2001

We last studied the relationship between the Dow Jones Industrial Average and the Dollar-Euro rate(inverse of the conventional Euro-Dollar rate) on 28th Dec. '99 and on 2nd July 2000.

Correlation Table     

The conclusions so far have been that:
(a) The Dow and the Dollar are positively correlated (the Dollar strengthens alongwith the DJIA) and that
(b) The Dollar can strengthen even if the Dow does not.

The second conclusion comes in for greater scrutiny in this Research.

The clue that it is not only the Dow that drives the Dollar-Euro rate comes from the fact that the Dollar strengthened over 1999-2000 even though the Dow remained largely rangebound between the two extremes of 11700 and 9800 (Period C alongside). Further, in the period Jan-March 2000, the Dollar strengthened even while the Dow fell and then later, over the period Oct-00 to Jan-01, USD fell while the Dow was steady.

We can say that during these two periods, the Dollar was following the NASDAQ rather than the Dow, with Correlation between the Nasdaq and Dollar-Euro during these periods being in the region of 55-77%(as shown in the Correlation Table above).

Thus, we now need to consider the future of not only the Dow Jones, but also of the Nasdaq to be able to forecast movements in Dollar-Euro (or more conventionally, Euro-Dollar).

Over the last few years the importance of the US Equity markets as a recipient of foreign capital inflows, especially from Europe, has grown considerably. While forecasting the long-term Dollar-Deutschemark rate used to be a matter of forecasting the 10 Year US Bond - German Bund interest rate differential till a few years ago, it is now probably more useful to try and predict the movements in the Dow Jones and the Nasdaq.

Dow-Dollar Nasdaq-Dollar


Looking ahead, while the Dow Jones stays above 10300, and certainly above 9700, the chances of it climbing above 11000 again remain alive. If the recent Interest Rate cuts in USA and the proposed Tax cuts fail to deliver the goods, only then would the Dow fall below 10300. As of now it might be a little early to write off the Dow.

It has been a very long time since Fiscal Policy was used as a tool in Economy management. It is also much more difficult to track and analyse the effects of Fiscal Policy and as Alan Greenspan's Monetary Policy has held sway over the past decade, the markets are probably not factoring in the Tax Cuts proposed by President Bush well enough. The possibility that these Tax Cuts may prove to be a positive catalyst for US Stocks has to be borne in mind.
             

Forecasting for the Nasdaq is tantamount to taking a stance on the future of "Technology". The bottom line, signified by the very strong Support at 2000-1700, is that Technological (and IT) advancement cannot be reversed.
At the same time, we are not going to see the logic-defying valuations of early 2000. Unless there is indeed a "Hard Landing", it would not be inconceivable for the Nasdaq to rise to 3400 by the end of the year, as compared to 2627 on 12th January 2001.

The first and obvious implication is that taking a stance on Dollar-Euro (or Euro-Dollar) is almost the same as taking a stance on the US Equity markets. Thus, a Long-Dollar / Short Euro position can be hedged with Put Options on the DJIA and on the Nasdaq. Or, looking at it the other way round,investments in US Equities can be hedged with a Short-Dollar / Long Euro position or with a Euro Call Option.

                                       

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