Unprecedented spending by both lawmakers and also the Federal Reserve to push away a pandemic induced market crash helped drive stocks to new highs last year, but Morgan Stanley professionals are actually worried that the unintended effects of additional cash and pent up demand when the pandemic subsides could very well tank markets this year-quickly and abruptly.
Dow Plunges Despite Fed Buyout Plan for Debt Traders work on the floor of the new York Stock Exchange.
The most significant market surprise of 2021 could be “higher inflation than a lot of, including the Fed, expect,” Morgan Stanley analysts said in a note on Monday, arguing that the Fed’s considerable spending throughout the pandemic has moved outside of just filling gaps left by crises and is as an alternative “creating newfound spending which led to the fastest economic recovery on record.”
By using its money reserves to purchase back again some $1 trillion in securities, the Fed has produced a market that is awash with cash, which usually helps drive inflation, and Morgan Stanley warns that influx could drive up costs as soon as the pandemic subsides and companies scramble to meet pent-up customer demand.
Within the stock market, the inflation risk is greatest for industries “destroyed” by the pandemic and “ill-prepared for what could be a surge in demand later 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’re 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 could be in for an average 18 % haircut in the valuations of theirs, relative to earnings, if the yield on 10-year U.S. Treasurys readjusts to complement latest market fundamentals an enhance the analysts said is “unlikely” but shouldn’t be totally 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 fourteen % gain last year.
“With global GDP output already back to pre-pandemic levels and also the economy not yet even close to fully reopened, we think the danger for far more acute priced spikes is actually higher compared to appreciated,” Morgan Stanley equity strategists led by Michael J. Wilson said, noting that the speedy rise of bitcoin as well as other cryptocurrencies is an indicator markets are already beginning to ponder currencies enjoy the dollar could be in for a surprise crash. “That adjustment of rates is just a matter of time, and it’s likely to happen fast and with no warning.”
The pandemic was “perversely” beneficial for large companies, Crisafulli said Monday. The S&P’s fourteen % gain pales in comparison to the tech-heavy and larger Nasdaq‘s eye-popping forty % surge last year, as firms-boosted by government spending-utilized existing strategies as well as scale “to evolve as well as save their earnings.” As a result, Crisafulli believes that rates needs to be the “big macroeconomic story of 2021” as a waning pandemic unearths upward price pressure.
$120 billion. That’s just how much the Federal Reserve is spending every month buying back Treasurys and mortgage-backed securities following initiating a considerable $700 billion asset purchase program in March. The U.S. federal government, meanwhile, has authorized some $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 robust economic recovery with its current asset purchase program, and he further noted that the central bank was ready to accept adjusting the rate of its of purchases when springtime hits. “Economic agents must be ready for a period of suprisingly low interest rates and an expansion of our balance 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 a lot more closely with the Fed to help battle economic inequalities through programs such as universal basic income, Morgan Stanley notes. “That is exactly the sea of change that may result in sudden effects in the fiscal markets,” the investment bank says.