Treasury bonds, dollar and gold seem mismatched versus stock-market boom

The stock market seems disconnected from other asset classes, says Morgan Stanley Wealth Management’s chief investment officer.

Hip, hip, hurrah? After shaking off a Moody’s downgrade, the S&P 500

SPX

+0.09%

finished Monday 19.68% above its April closing low, just inches from reaching the 20% level that traditionally marks a bull market.

Also notable for Monday was JPMorgan CEO Jamie Dimon, who came out swinging against an ”extraordinary amount of complacency” right now in these V-shaped markets.

Our call of the day adds another voice to the complacency worries. Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management, warns equity investors are ignoring three big market disconnects that might come back to bite them.

Shalett sees “unequivocal confidence” among investors that the U.S.-China tariff pause hammered out just over a week has put a permanent lid on trade war uncertainty, which has brought stocks back to where they were on Jan. 1.

“Such a round-trip amid still-deteriorating earnings estimates suggests ever richer forward valuation multiples than at the start of the year,” she wrote in a note. That is, investors are now being prepared to pay a lot more for the multiple of next year’s earnings per share.

“While we have noted our skepticism regarding the pivot, other asset classes also signal the coast may not be fully clear,” she said, diving into signs of potential stock trouble via three major assets.

First up, bonds. “While rising front-end U.S. Treasury yields appear to confirm confidence in economic growth, the 10-year yield’s grind toward 4.5% is noteworthy, as wider term premiums and higher real rates indicate a keen focus on U.S debt and the upcoming tax, debt ceiling and budget bills,” she said.

Nearly all proposals for those three major bills suggest a ballpark $2 trillion, at least, in added debt, potentially driving interest expenses over the next decade to as much as 50%, said the CIO. “By definition, this means higher rates for longer and lower equity multiples,” she said.

Another “profound disconnect” is the dollar, which has seen persistent weakness. Since a Jan. 8 peak, the dollar has dropped 8% versus major currencies, “apparently a victim of flows and global reserve rebalancing.”

“How odd that both oil and the dollar are now positively correlated, as opposed to the reverse. If the dollar is entering a new secular regime of relative weakness, as we anticipate, it too could be signaling lower equity multiples, in this case via the capital flows channel,” she said. In other words, a weak dollar may spook foreign investors out of U.S. stocks.

Finally, gold is another blind spot, said Shalett. Historically, secular equity bull markets has seen stocks outpace gold, but since 2022, the commodity has outpaced U.S. equities. “Strength in gold, disconnected from its role as a ‘safe haven,’ indicates likely shifts in central bank foreign reserve diversification, another reminder that risk premiums in other asset classes may not be providing much shelter from potential storms,” she said.

Shalett warned that investors hoping for a resumption of the 2023-2024 “Goldilocks environment” — when U.S. stocks saw support from falling real rates and inflation-resistant dollar strength — could be disappointed.

“Consider using risk-asset repricing to rebalance and position for potential 5%–10% average U.S. equity returns amid increased structural volatility, higher real rates and US dollar weakness. This is not the time to count on valuation expansion,” she said.

The CIO suggests adding “diversifying positions” in international stocks, commodities, energy infrastructure and hedge funds, along with overweight or bullish exposure to short-to-neutral duration investment grade and municipal bonds.