Unprecedented spending by both 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 experts are actually concerned 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 biggest market surprise of 2021 could 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 beyond just filling cracks left by crises and it is as an alternative “creating newfound spending which led to probably the fastest economic recovery on record.”
By making use of its cash reserves to pay for again some one dolars trillion in securities, the Fed has produced a market that’s awash with money, which typically helps drive inflation, and Morgan Stanley warns that influx could possibly drive up prices as soon as the pandemic subsides and companies scramble to meet pent-up consumer demand.
Within the stock market, the inflation danger is greatest for industries “destroyed” by the pandemic and “ill-prepared for what might be a surge in demand later this year,” the analysts said, pointing to restaurants, travel and other customer and business-related firms which could be made to drive up prices in case they’re unable to cover post Covid demand.
The top inflation hedges in the medium-term are commodities as well as stocks, the investment bank notes, but inflation could be “kryptonite” for longer-term bonds, which would ultimately 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 may be in for an average eighteen % haircut in their valuations, relative to earnings, if the yield on 10 year U.S. Treasurys readjusts to complement current market fundamentals an increase the analysts said is “unlikely” but should not be entirely ruled out.
Meanwhile, Adam Crisafulli, the founder 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 compared to the index’s 14 % gain last year.
“With worldwide GDP output currently back to pre pandemic amounts and the economy not yet even close to completely reopened, we imagine the risk for far more acute priced spikes is greater compared to appreciated,” Morgan Stanley equity strategists led by Michael J. Wilson said, noting that the quick rise of bitcoin along with other cryptocurrencies is an indicator markets are today choosing to ponder currencies enjoy the dollar could be in for a sudden crash. “That adjustment in rates is just a question of time, and it is likely to happen fast and with no warning.”
The pandemic was “perversely” positive for big companies, Crisafulli said Monday. The S&P’s fourteen % gain pales in comparison to the larger and tech-heavy Nasdaq‘s eye popping forty % surge last year, as firms-boosted by federal government spending-utilized existing methods and scale “to develop and preserve their earnings.” As a result, Crisafulli concurs that rates should be the “big macroeconomic story of 2021” as a waning pandemic unearths upward price pressure.
$120 billion. That’s how much the Federal Reserve is actually spending each month buying again Treasurys along with mortgage-backed securities following initiating a considerable $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 result of the pandemic.
Chicago Fed President Charles Evans said Monday he’d “full confidence” the Fed was well positioned to help spur a strong economic recovery with its current asset purchase plan, and he more mentioned that the central bank was open to adjusting its rate of purchases when springtime hits. “Economic agents must be equipped 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 could work more closely with the Fed to help battle economic inequalities through programs including universal standard income, Morgan Stanley notes. “That is just the ocean of change which can lead to unexpected outcomes in the financial markets,” the investment bank says.