Believe that the weak dollar means strong stocks? If so, it's time to buy

Right now, about $360 billion is sitting in money market funds. But surely some of it must be looking at the 62% rise in the S&P 500 since the March 6 low and wondering whether it should go into stocks. Unfortunately, investors holding that cash have no easy answer: There doesn't appear to be any logical explanation for why stocks go up and down -- even though plenty of theories are advanced every day.

One theory gaining credence these days says the weak dollar is pushing up stocks. If you think this theory has any credence, then you should invest in stocks for at least the next two years. Before getting into why this could make sense, remember that many theories get used to explain stock price movements.

Equity prices forecast where the economy will be in six months, stocks climb on a wall of worry, stocks rise if more cash is going into them than is going out, stocks rise on better-than-expected earnings and guidance, stocks rise if the team that wins the Super Bowl comes from the National Football Conference (more precisely, from the original National Football League, pre-American Football League merger), and so on.

I'm persuaded that the money flows theory makes the most sense, but the general public can't track the data in a useful way. So we're left with what seems to be the latest theory that appears to be working now: A weak dollar is good for stocks. Unfortunately, that theory does not seem to hold over the long run. How so?

Shorting the Buck and Buying Commodities?

The dollar is down 80% in the last decade -- from 0.827 dollars per euro on Oct. 26, 2000 to 1.485 dollars per euro on Nov. 13, 2009 -- and the S&P 500 is down 21% (from 1,380) during that same time. So, it's clear that a weak dollar doesn't closely correlate with a rising stock market. Nor is the dollar's value movements the biggest cause of stock market movements.

However, stocks have been rising this year without a clear explanation. One possibility I've heard traders mention repeatedly is that with the government taking on so much debt and the Fed pledging to keep interest rates low, traders are shorting the dollar and buying commodities, such as oil and gold.

Also, the weak dollar could make it easier for U.S. exporters to sell their goods overseas. And as the eurozone exits its recession, the governments there could start raising interest rates. If the Fed doesn't raise rates until 2011, the dollar will get even weaker relative to other currencies, which could spur the profits of U.S. exporters and push the U.S. market higher (if the theory holds).

I've decided to make a small wager on this theory by switching some money into an S&P 500 index fund. I'll provide periodic updates on whether that was a good bet.

Peter Cohan is a management consultant, Babson professor and author of nine books, includingCapital Rising (due in June 2010). Follow him on Twitter.

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