The recent rally in the euro is a positive sign for the S&P 500, because it shows appetite for risk is still strong and the S&P could hit 1,000 this summer, Kevin Cook, market analyst at PEAK6 Investments, told CNBC Wednesday.
"The positive correlation here between the S&P 500 and the euro has been unbelievable in the past three quarters," Cook, who is also a technical analyst, told "Worldwide Exchange".
As is frequently the case in the realm of finance, seemingly strong relationships can be temporary in nature. In fact, that is the case between the Euro and the S&P 500. Over a longer period of time, the correlation all but completely disintegrates.
The relationship breaks down because the U.S. economy is not disproportionately dependent on U.S.-European Union trade. As a result, the apparently strong relationship between the U.S. Dollar-Euro foreign exchange and S&P 500 is not an enduring feature of the financial landscape.
The recent “unbelievable” correlation between the Euro and S&P 500 was likely produced by special but temporary circumstances. The rapid escalation and then gradual waning of the global financial crisis probably created the seemingly intense relationship between the Euro and the S&P 500.
During extreme market turbulence, many securities and financial instruments—even completely unrelated ones—often move in tandem during a massive flight to safety. Over the past 9 months, there was a full-fledged financial panic, followed by some return of an appetite for risk beginning in March 2009. At first, there was a massive rush out of stocks and into the U.S. dollar. Both the S&P 500 and Euro fell sharply. Once the panic abated and the appetite for risk began to return this spring, capital began flowing back into a broader range of securities and financial instruments. During that time, the S&P 500 and Euro rose in strong tandem, though not as closely as had been the case during the panic.
However, given the past data, over the passage of time, it would be more likely than not that the previously far weaker relationship would begin to reassert itself as the special circumstances behind the recent strong co-movements would no longer be relevant. Already, there are early hints that the relationship is now weakening. Although the r2 between the Euro and S&P 500 has averaged 0.732 over the past year (July 1, 2008-June 30, 2009), it has faded somewhat to 0.663 for the first six months of 2009 and to 0.509 since March 15.
Therefore, if one is looking for hints as to the possible direction of the S&P 500, one should look for developments beyond the Euro to support such a move. Over the longer haul, relying largely on the Euro could be potentially hazardous given the weak medium-term correlation.
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