Two weeks ago, JPM’s Marko Kolanovic put out a very interesting observation, according to which further gains in the S&P500 are capped to the upside due to one very popular reason: the US Dollar. What he said, in a nutshell, is that while a weaker dollar is beneficial for energy (clearly) and multinational stocks, it is a stronger dollar that has been driving the broader S&P 500 higher (which correlates ~30% with the USD) due to the dominant influence of Momentum and Low Volatility stocks in the index.

In other words, as the dollar weakens, it supports the most beaten down, energy, sector (which has now undergoing a record short squeeze), but it ultimately will pressure the broader market lower through Tech and Momo. As Kolanovic called it: “a market trapped by the USD.“

This is what Kolanovic said exactly:

We are not excited about owning the S&P 500 as core exposure to risky assets. The S&P 500 is capitalization weighted, has high momentum bias, is internet heavy, and is implicitly long USD (when the USD is near historical highs). The current correlation of the S&P 500 to USD is ~30%. One of the reasons behind the positive correlation of the S&P 500 to USD is the high weight in Momentum and Low Volatility stocks in the index, and these stocks’ positive correlation to USD. At the same time, the index has low weight in Value stocks that are negatively correlated to USD (correlation of momentum, value and S&P 500 to USD are shown in Figure 1). When it comes to macro drivers of equities, the S&P 500 may be trapped by USD: it can’t rally to new highs without USD (momentum sectors, FANGs, etc.), and at the same time the strong USD is capping any significant upside due to its negative impact on EPS (via value segments such as multinationals and energy).

We didn’t have long to wait to see precisely what Kolanovic meant, as today’s market provides a perfect confirmation.

On one hand we have surging Energy stocks, not just today, but over the past five days. On the other, we have seen a steady drop lower in the USD over the same time period, which initially kept Tech and Momentum stocks flat…

… but today has led to a decisive move lower in 2015’s dominant tech group, the FANGs:

Which presents an unpleasant dilemma for the Fed: can it push the S&P higher when it is trapped by a stronger dollar, and if not, can is push the S&P higher when it is trapped by a weaker dollar as well.

What it really means, is that hopes of multiple expansion going forward can be forgotten: recall that the S&P now is already at a higher multiple (and thus more expensive) than it was at the beginning of the year; it also means that unless somehow the S&P500 constituent companies can once again find a way to grow their real earnings (which as we have showed recently are at 2010 levels), any breakout attempts for the S&P500 will fail.

And that is the real problem: how to grow revenues and earnings in a world in which global trade is crashing, in which sovereigns and consumers have record debt, and where wage growth – in the US – just posted its biggest monthly collapse in history.