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Moves to weaken the dollar's hold on global trade and its status as a top reserve currency are a threat to US stocks, according to Lisa Shalett, CIO of Morgan Stanley Wealth Management.
Shalett said in a note on Monday that the strength of the US dollar is under structural pressure that could spill over into US equities.
Urging investors to "consider preparing for a US dollar regime shift," she said the recent rally in gold and bitcoin, the end of Japan's yield curve management, and strained US-China relations could push the US dollar to its limit and pose challenges for stock valuations.
The ongoing rally in US stocks owes much to high liquidity enabled by policymakers. The "heart of the easy money regime" is the dollar's momentum that brought down import inflation, reduced energy prices, and empowered US debt and deficits financing, but those dynamics will be reversed soon, Shalett said.
"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 said in the note.
Surging god and cryptocurrency values are dealing the first blow to the dollar's strength. Gold has surged 18% since last October, while bitcoin, the world's largest crypto, has jumped more than 50% just this year to notch fresh all-time highs above $73,000 in March.
"Both moves could coincide with concerns about more-persistent inflation, with confirmation potentially coming from rebounding global cyclical commodities like oil and copper," Shalett wrote.
Meanwhile, Japan recently entered its first bull market in 34 years and the Bank of Japan has abandoned yield-curve control measures. Shalett predicts that the likelihood of BOJ policy adjustment will persist.
"This should allow rates to reprice upward and help strengthen the yen versus the dollar. Together with retirement incentives and the improved outlook for Japanese equities, this could drive repatriation flows out of US stocks," the CIO said.
Escalating tensions with China over issues ranging from involving semiconductors to TikTok, may also contribute to the de-dollarization trend.
"Recent gold price action, meanwhile, could be related to China's desire to build credibility for the renminbi. Given that US presidential campaigns are likely to feature both candidates projecting a 'strongman' stance toward China, pressure on the US dollar, inflation and interest rates may persist," Shalett said.
A broader decline in the dollar would consequently impact US stocks through earnings multiples, which have largely fueled the market's recent gains, she added.
