IWM Russell 2000 Small Cap ETF, EEM MSCI Emerging Markets ETF and USD US Dollar Daily Charts

The Three Stooges above show the correlation of the US dollar to small caps and emerging market stocks. It is easy to see the relationship. Take a second to look for yourself to figure out what is going on. You can see that when the dollar drops, IWM, the Russell 2000 Small Cap ETF, and EEM, the MSCI Emerging Markets ETF, pop. Conversely, when the dollar rallies, small caps and emerging markets fall.

If you remove all other background noise and influences, a weaker dollar will send emerging markets higher since it is easier for those companies to service their dollar-denominated debt. The consensus from Wall Street analysts is that the dollar will weaken this year which makes the EEM and emerging market stocks a screaming buy (according to them). Keystone forecasts sideways chop to the currencies all year long. Well, those analysts picked the wrong horse so far this year since the small caps lag and are not yet overtaking their record highs while the other indexes are singing and dancing to all-time highs.

A weaker dollar will provide an advantage to US exporters and manufacturers and many of these companies are in the small cap index. A weaker dollar also sends commodities, gold and silver higher which provides a boost to the stock indexes. The textbooks will say that small caps typically outperform large caps during long periods of dollar strength but in today's markets, with all the central banker intervention and other funny business, splitting hairs with such fine tools seems like a fool's errand.

The blue lines show where the dollar and small caps and emerging markets move in unison. The divergence began in May 2019. That was when the Federal Reserve was 'patient' and the trade deal with China looked likely, although it then fell apart. The Fed was touting a strong economy at that time. What is interesting is that over the last week, the three stooges have moved in unison again.

This is due to the stock indexes, the IWM and EEM, suddenly reversing course due to the PBOC injecting liquidity into markets to battle the conoravirus. The central bankers are the market. The dollar is at higher highs for this year so the stock market should be at lower lows if this inverse correlation, that has been in play for 9 months, continues. This information is for educational and entertainment purposes only. Do not invest based on anything you read or view here. Consult your financial advisor before making any investment decision.