By Morgan Stanley’s top stock strategist is eyeing one risk in particular that could threaten the stock market’s big rally: a stronger US dollar.
According to the firm’s chief US equity strategist, Mike Wilson, a dollar re-strengthening could hinder stock gains. The greenback weakened as markets prepared for steep rate cuts, but that move has reversed in recent weeks as strong economic data makes more aggressive policy easing less likely.
“One of the things that could cause the rally to kind of slow down is if the dollar were to strengthen again. And that’s starting to happen. So that’s probably the one thing we’re watching for now that could kind of throw a wrench in this pace of new records every day,” Wilson said in a Tuesday interview with Bloomberg Radio.
Wilson says US dollar liquidity, or dollar supply growth, has started rising rapidly in the last month or so after bottoming out almost two years ago, mostly due to expanded balance sheets in China and Japan and a weaker dollar.
A stronger dollar would thus interrupt the rally, he says.
The dollar has gained about 2% against a basket of rival currencies since the start of the month. That renewed strength comes as investors price in a slower easing cycle from the Federal Reserve amid a hot economy and still-elevated inflation.
Wilson’s call comes two years into the market’s bull rally, with major indexes continuing to hit fresh all-time highs. The S&P 500 index has clocked three records in the last week, and is up over 23% since the start of the year.
Wilson attributes the market’s gains to easing from most major central banks, including those in the US and China, and says the rally is broadening out.
“It’s a policy driven rally, and it’s very robust. And it’s even broadening out now,” Wilson said, adding, “That will continue until basically either you get a real shock on the economic front, or fundamentally speaking, you get a restriction on a liquidity front.”
Wilson said almost all of the returns in the last year have been a result of multiple expansion, rather than higher earnings revisions. He said multiples are now 22 times the index level, which has happened only a few times in recent history.
He added that even though the rally is fiscally driven, it isn’t threatened by the upcoming results from the presidential or congressional elections.
“Neither party has really shown any willingness or ability to slow the freight train on fiscal spend. I think the bigger concern is how do they fund it,” he said.
Wilson says a bigger risk will emerge when the bond market starts feeling pressure from the size of fiscal deficits, but it’s tough to say when that might happen.
“Maybe they can pull it off. Maybe we can inflate our way out and we can get better growth next year,” Wilson said. “That’s the game that we’re playing, and right now that’s a bull market.”
