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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.
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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.
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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.
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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.
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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.
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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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