A ‘disconnect’ between stocks, bonds and currencies is raising a flag

A disconnect between equities, bonds and the currency market as tax reform legislation nears passage has one equity strategist concerned.

The S&P 500 has rallied to record highs as investors price in hopes of corporate tax cuts, but the Treasury market and U.S. dollar are not behaving in a similarly bullish manner, said Matt Maley, equity strategist at Miller Tabak. This, along with the stock market’s overbought condition, will be of concern in the beginning of 2018, and he has three charts to back up his cautious view. Here’s why.

• The S&P is quite overbought on a near-term basis, as its weekly relative strength index is at its most overbought in history. This indicates the market may be ripe for a “sell the news” reaction to the sweeping tax bill, should it pass.

• Meanwhile, the bond market as measured by the iShares 20+ Year Treasury Bond exchange-traded fund (TLT) has traded in a sideways range for months.

• The U.S. dollar index, too, has moved in a similarly narrow range rather than rallying on the prospect of economic growth and higher interest rates.

• This disconnect between various asset classes is raising the question of whether the tax reform bill is truly going to have a major bearing on the economy. While the stock market is saying yes, the other markets are saying perhaps not so much.

Bottom line: While stocks have rallied to all-time highs on tax reform-related optimism, bonds and the U.S. dollar have not reacted in a similar fashion. This raises the question of the kind of economic impact the bill could have.