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(Bloomberg) — The chief investment officer of Morgan Stanley Wealth Management has a warning for stock bulls: the structural forces weighing on the dollar are threatening to spread to US equities in turn.
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“Consider preparing for a US dollar regime shift,” cautioned Lisa Shalett. Deteriorating relations with China, the end of yield curve management in Japan and rising Bitcoin and commodity prices suggest the currency’s run “might be hitting its limit.”
“While correlation is not causation, the correlation of US dollar strength to P/E ratios is worth monitoring now that the greenback’s bull market cycle may be maturing,” she wrote in a note Monday.
According to Shalett, that dollar strength has been at the “heart of an easy money regime” in the US — by pushing down import-related inflation and pressuring energy prices lower — that has boosted the performance of the equity market of late.
Shalett recently encouraged investors to look abroad for future stock returns as a hedge against a potential correction in US equities. She, along with a handful of others on Wall Street have cautioned on the latest bull run in stocks even as US benchmarks continue to reach new milestones.
After falling nearly 3% in 2023, the greenback got off to a hot start this year as traders rapidly dialed back expectations of monetary easing from the Federal Reserve. But those gains have stalled even as bets on the pace of rate cuts were further reined in. A Bloomberg gauge of the dollar has slipped 0.5% this March while Bitcoin and gold prices traded to recent, record highs.
Pressuring the dollar is the prospect of Bank of Japan tightening its policy even as major Group-of-10 peers cut interest rates, that should boost the yen and Japanese rates and repatriation flows out of US equities, Shalett said. Fractured US-China relations, especially in the midst of the US presidential election, also threaten to accelerate de-dollarization — a move perhaps reflected in rising gold prices — she said.
Read more: Yen Futures Highest Since 2007 Ahead of Possible BOJ Shift
A broader downtrend in the dollar would then flow through to US stocks via earnings multiples, the expansion of which has been responsible for much of the market’s recent gains.
“If global policy starts rebalancing toward a pre-GFC mix, or market euphoria ushers in a capital markets bust and a weaker dollar, investors may benefit from more asset and geographic diversification,” Shalett said.
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