For quite some time now the stock market and the dollar have been locked in a reverse correlation. When the dollar went up the market went down and so forth.

In particular 2009 has seen that correlation play out in dramatic fashion. The stock market had a bottom in November 2008 and then the final bottom of the bear market run down in March 2009.

The stock market as measured by the Dow 30 industrials bottomed in March at which time the Dollar index negatively correlated by peaking in price. In all the retracements and minor corrections that occurred, since then, in the Dow the dollar also experienced a similar but opposite reaction.

Within the last week or so the dollar has begun to react with slightly more strength and the market seems to be attempting to dislodge that inverse correlation between a falling dollar and a rising market.

On Friday Dec. 4th. the Dow was up strongly in the morning with a rising dollar. In the weeks and months prior to this if the dollar had risen strongly the market almost inevitably would have fallen. The Dow did give back much of its gains during the late morning and into the afternoon while managing to finish with a small gain on the day.

The dollar had a stellar day up strongly as measured by the dollar index with a 1.45% rise. The Dow itself rose 22.75 which was a considerably lower close than the high of the day but still a respectable showing given the dollar’s strength. This was the strongest day for the dollar since the first week of June.

Too early to tell if this portends a change of trend for the dollar or the overall stock market but it does give some minor indication that the market may not respond as negatively to a rising dollar as it has in the last year or so.

Within the last 10 years there have been periods of positive correlation between stocks and the dollar. In 1998 and 1999 there was significant positive correlation between the dollar and stock market activity. The internet boom was taking strong hold then and the perception of lower budgetary deficits by the Federal Govt. was helping to keep the dollar stronger.

There were some minor temporary disconnects from this positive correlation in the next couple of years but none was severe until the market was near a bottom in 2003. From March 03 until June the correlation turned negative and then again from Aug. 03 until Feb. 04 and then again from Oct. 04 to Dec. 04. For a period of two months from March 06 to May 06 we have this correlation once again. It occurs again several times in 07 and of course in 08. The most significant disconnects occurs during 09 which persists for almost all of the year.

The dollar can fall further if not supported by world governments who rely on its value and the stock market can continue to go up. The recent positive correlation may mark an interesting turning point in the dollar market relationship. Who knows whether it will persist or not but the dollar appears to be strengthening for a bottom of sorts in the short term and the market has run significantly higher in the last 9 months. Many have been calling for a market correction which would be healthy for a continued higher market.

Govt. policy has made the dollar weak and free money for the banks has contributed to a healthy stock market rebound in 2009. Like all parties, it must end sometime. Interest rates will rise at some point. If they don’t we may repeat a Japan like fiasco of the 1980′s and 1990′s where cheap money led to excesses that created a lengthy recession and falling stock market values that have not recovered.

What does that mean for the dollar and the stock market. For the time being the dollar and stock market will probably still have an inverse correlation. The perception of continued low interest rates will keep the dollar lower against other world currencies. Many of our major corporations do substantial business overseas and therefore benefit from a falling dollar as they can export more cheaply and benefit from higher foreign currency values abroad.

The recent rise in the dollar means that investors believe interest rates will rise before too long. If they do that will be a short term negative for the market although it may currently be pricing some of that into the mix.

Check out the chart on the Dollar/Dow-30 on our website to see the relationship we have been talking about in this article.