What would the value of S&P 500 index be if it were value-adjusted based on the dollar index?

Many of us are familiar with the dollar index. We know that the value of our dollar versus a basket of currencies fluctuates as a result of many reasons. Let's take a look at our dollar index, which is conveniently available from Federal Reserve's economic data repository (FRED).

What would the S&P 500 Index look like if we adjusted for the rise or fall of the dollar? We typically adjust for inflation (which is in our currency), but do we know what impact our central bank, government spending, and monetary policies have upon the dollar? To answer that, we'll use the March 1973 base of 100 for the dollar and adjust the S&P index price by a relative movement in the dollar index.

The next chart shows the dollar index, the S&P 500, and the dollar-adjusted S&P.

 

 

As the chart illustrates, with the dollar valued at 100, the current S&P would be just above 800. This makes sense. As our dollar weakens versus a basket of currencies, the S&P price must rise to compensate for lesser value (which is why you have to be a FOREX expert to accurately guess the future direction of the S&P). Note that our dollar is near its historic low. So, what are the odds of a continuing decline, especially given that during 2012 we can anticipate US austerity taking hold as a primary election issue? At least with this data, we can calculate a dollar-adjusted "fair value" for the S&P 500. We can also note that the "spread" between the dollar and dollar-adjusted index is very large. Any guesses to whether this continues to diverge or move back to a mean?

Let's continuing our study by looking at the impact of dollar-adjustment on earnings. Recently Howard Silverblatt, Senior Index Analyst at Standard & Poor's, showed the percentage of profits from overseas for the S&P 500. As of 2010, 46.4% of earnings were attributed to overseas sales.

Armed with this knowledge, let's examine the impact on earnings and adjust those with a rise or fall in our dollar. The next chart displays our dollar index chart, reported earnings (trailing 12 months), and the equivalent earnings if adjusted for the currency movements.

 

 

We see that today's earnings would be around 60 if adjusted for the lower valued dollar, not the nominal 89. Perhaps a similar adjustment will apply to future earnings, now estimated at 95 for 2012. On the other hand, this chart underscores the "currency risk" to earnings, given the already high 30% premium due to a low dollar. But consider what might be the direction of the dollar if our government presents a sound and palatable fiscal policy (mandated by the 2012 election). Or imagine the value of the dollar if the Euro fades or disappears, which may not be not an unthinkable prospect over the next several years. Indeed, why the euro now trades at such a premium to the dollar is anyone's guess, but it certainly shows how bad our dollar is viewed at present.

Hopefully, these charts will provoke some thought on the true value of both earnings and the S&P 500 when looking through our "green-colored" lenses.

 

 

 

 

(c) Advisor Perspectives (dshort.com)

www.advisorperspectives.com