The 'Real Return' of the S&P 500 for US Based Investors Since 2005

We are all familiar with the quoted value of stock indexes like the DOW or S&P 500 that we see on websites and TV news channels. Even though these quotes are of course accurate they are also ‘currency nominal', meaning that they ‘hide' the affects of US Dollar currency fluctuations. Recently the relationship between USD weakness and equity strength has been pronounced. The correlation has been very high between the S&P 500 (or any other domestic equity indexes) and a weakening US Dollar relative to a basket of foreign currencies. A major component of this basket is the Euro, so it is worth examining the difference in ‘real return' currencies play in stock market indexes. Below is a chart showing both the nominal S&P 500 and the USD adjusted S&P 500 pegged to April 2005 values through October 2011. This would represent the actual real return (relative to world wealth) for a US based investor in the US stock market as the adjusted figure accounts for US Dollar currency fluctuation. This same ‘adjusted' return can be approximated by establishing a long position in both the S&P 500 (iShares S&P 500 ETF

) and a long US Dollar position (Powershares US Dollar Bullish ETF

). You will notice while the ‘nominal' return of the index during the period was -8.3% (1200 at the start to 1099 on October 3 2011) the ‘US Dollar' adjusted return was -15.1% (1200 at start and 1019 on October 3 2011). So US based investors (relative to the rest of the world) did not lose the headline 8.3% through the period, but really lost a little more than 15%. If an investor is neutral or bullish on the relative long term prospects for the US Dollar vs. a basket of foreign currencies it might be beneficial to hold both long positions. Making the assumption the US Dollar does not fall in value (which is a large assumption) the investor would most likely be better off as they would have sacrificed no real return and decreased volatility by holding the negatively correlated positions. With the European debt crisis now in the forefront and the possibility of Euro/Emerging currency weakness this concept should be understood before investing in domestic equities, foreign equities, or currencies. For more information on our portfolios, investment philosophy, and links to archived quarterly investment newsletters please visit www.tfgllc.com.