Unprecedented spending by each lawmakers as well as the Federal Reserve to stave off a pandemic-induced market crash helped drive stocks to new highs last year, but Morgan Stanley consultants are worried that the unintended consequences of more dollars and pent-up demand once the pandemic subsides could tank markets this year-quickly and abruptly.
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The most significant market surprise of 2021 may be “higher inflation compared to many, including the Fed, expect,” Morgan Stanley analysts said in a note on Monday, arguing that the Fed’s massive spending throughout the pandemic has moved outside of just filling holes left by crises and is rather “creating newfound spending which led to the fastest economic recovery on record.”
By using its cash reserves to buy again some $1 trillion in securities, the Fed has produced a market that’s awash with money, which generally helps drive inflation, and Morgan Stanley warns that influx could possibly drive up costs as soon as the pandemic subsides and companies scramble to satisfy pent up customer demand.
Within the stock market, the inflation risk is actually greatest for industries “destroyed” by the “ill-prepared and pandemic for what could be a surge in demand later on this year,” the analysts said, pointing to restaurants, travel and other consumer in addition to business-related firms that could be forced to drive up prices if they are unable to satisfy post-Covid demand.
The best inflation hedges in the medium term are stocks and commodities, the investment bank notes, but inflation can be “kryptonite” for longer term bonds, which would eventually have a short-term negative effect on “all stocks, should that adjustment take place abruptly.”
Ultimately, Morgan Stanley estimates firms in the S&P 500 might be in for an average 18 % haircut in their valuations, relative to earnings, if the yield on 10 year U.S. Treasurys readjusts to match up with latest market fundamentals-an enhance the analysts said is actually “unlikely” but shouldn’t be totally ruled out.
Meanwhile, Adam Crisafulli, the founding father of Vital Knowledge Media, estimates that the influx in Fed and government spending helped boost valuation multiples in the S&P by a lofty 16% more than the index’s 14 % gain last year.
“With global GDP output currently back to pre-pandemic amounts as well as the economy not yet even close to completely reopened, we think the danger for more acute priced spikes is actually higher than appreciated,” Morgan Stanley equity strategists led by Michael J. Wilson said, noting that the fast rise of bitcoin and other cryptocurrencies is a sign markets are right now opting to ponder currencies enjoy the dollar could possibly be in for a surprise crash. “That adjustment in rates is only a matter of time, and it’s likely to take place fairly quickly and without warning.”
The pandemic was “perversely” positive for big companies, Crisafulli said Monday. The S&P’s 14 % gain pales in comparison to the larger and tech-heavy Nasdaq‘s eye-popping 40 % surge last year, as firms-boosted by federal government spending utilized existing strategies and scale “to evolve and save their earnings.” As a result, Crisafulli agrees that rates needs to be the “big macroeconomic story of 2021” as a waning pandemic unearths upward cost pressure.
$120 billion. That’s just how much the Federal Reserve is spending every month buying again Treasurys and mortgage backed securities following initiating a substantial $700 billion asset purchase program in March. The U.S. federal government, meanwhile, has authorized several $3.5 trillion in spending to shore up the economic recovery as a direct result of the pandemic.
Chicago Fed President Charles Evans said Monday he had “full confidence” the Fed was well positioned to help spur a strong economic recovery with its present asset purchase program, and he even further noted that the central bank was open to adjusting the rate of its of purchases as soon as springtime hits. “Economic agents needs to be prepared for a period of really low interest rates as well as an expansion of our stability sheet,” Evans said.
Things to WATCH FOR
President-elect Joe Biden nominated former Fed Chair Janet Yellen to head up the Treasury Department, a signal the federal government might work far more closely with the Fed to help battle economic inequalities through programs including universal standard income, Morgan Stanley notes. “That is exactly the ocean of change that may result in sudden results in the fiscal markets,” the investment bank says.