When Stocks, Bonds and Oil Move Together

0:00Andrew Sheets:Welcome to Thoughts on the Market. I'm Andrew Sheets, Global Head of Fixed Income Research at Morgan Stanley. Today, how to square a market that is both highly correlated and highly divergent at the same time. It's Tuesday, June 2nd at 3 p.m. in London. A market of one. That may be a way that you hear investing described these days, and strictly speaking, it's accurate. Stocks and bonds, the two big asset classes that form the bulk of most investors' portfolios, are moving in unusual lockstep. Stocks are rising when yields fall, and vice versa, with the most consistency in over 20 years. And both, perhaps unsurprisingly, are moving in close relationship with the price of oil.

0:45Andrew Sheets:At this point, it all seems pretty clear. The Iran conflict is a big deal for markets, representing the largest disruption to global energy supply in history. Of course, stocks and bonds and oil are all moving together based on the perception of how this enormous issue resolves. In doing so, they suggest that the conflict still remains quite important, even as markets appear quite strong. Just as we can measure the extent to which stocks, bonds, and commodity prices move together, we can also track how individual stocks move relative to each other. And so are stocks also rising and falling together, like we see with these big asset classes.

1:24Andrew Sheets:No. In fact, without exaggeration, it's the complete opposite. There are a few ways to measure how the individual stocks within, say, the S &P 500 are moving relative to one another. But all of them say the same thing. Day-to-day, stocks are moving with unusual dispersion and independence. At the same time that the relationship between stocks and bonds is the tightest in over 20 years, the relationship between stocks within the S &P 500 to each other is the loosest. If Iran is the factor driving the tight linkage that we discussed between stocks and bonds, artificial intelligence may be the culprit behind the opposite effect when we get down into individual companies.

2:06Andrew Sheets:The perception that some companies will be incredible beneficiaries of AI while others will be left behind would explain at least part of the divergent performance. And so would an attention gap. With so much focus and positioning in AI-sensitive names, other parts of the market can quickly feel forgotten and thus move more independently. Indeed, while the S &P 500 is back near all-time highs, the market's advanced decline line, a measure of how many stocks are going up versus going down, is lower than where it was in late February or mid-April. We see a few implications to all of this. First, while stocks and bonds are closely linked for the moment, we think that this correlation would flip under more significant energy market stress.

2:53Andrew Sheets:Were the price of oil to spike to our commodity team's bear case of$130 to$150 a barrel, we think yields would start to fall as the market would turn more concerned about the effect of all of this on growth. So, while the diversification of bonds has been disappointing so far, we do think that it will improve and materialize when it really matters. In equities, this dispersion means that stock selection can allow one to stand out from the overall market. Indeed, if one considers themselves a stock picker, low correlation between stocks is exactly the market that you would hope to have, and also means that many individual names may not be as heady as the broad market levels would imply.

3:34Andrew Sheets:As discussed on this program recently, my colleague Michael Wilson and our U.S. equity strategy team expect U.S. stock performance to broaden out from here. Thank you, as always, for your time. If you find Thoughts of the Market useful, let us know by leaving a review wherever you listen, and also tell a friend or colleague about us today. The preceding content is informational only and based on information available when created. It is not an offer or solicitation, nor is it tax or legal advice. It does not consider your financial circumstances and objectives and may not be suitable for you.