Unprecedented spending by both lawmakers and also the Federal Reserve to stave off 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 pent up demand and extra money 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 largest market surprise of 2021 could be “higher inflation than a lot of, like the Fed, expect,” Morgan Stanley analysts said in a note on Monday, arguing that the Fed’s massive spending during the pandemic has moved beyond merely filling cracks left by crises and it is rather “creating newfound spending that led to the fastest economic recovery on record.”
By using its cash reserves to buy back some $1 trillion in securities, the Fed has created a market that is 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 cover pent-up customer demand.
Within the stock market, the inflation danger is greatest for industries “destroyed” by the “ill-prepared and pandemic for what may well be a surge in demand later on this year,” the analysts said, pointing to restaurants, other customer and travel in addition to business related firms that could be made to drive up prices in case they are unable to satisfy post Covid demand.
The most effective 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 eventually have a short-term negative influence on “all stocks, must that adjustment come about abruptly.”
Ultimately, Morgan Stanley estimates firms in the S&P 500 might be in for an average eighteen % haircut in their valuations, family member 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 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 fourteen % gain last year.
“With worldwide GDP output already back to the economy and pre pandemic amounts not yet even close to totally reopened, we believe the chance for far more acute priced spikes is actually greater than appreciated,” Morgan Stanley equity strategists led by Michael J. Wilson said, noting that the rapid rise of bitcoin as well as other cryptocurrencies is a sign markets are today starting to ponder currencies enjoy the dollar could be in for a surprise crash. “That adjustment of rates is simply a situation of time, and it is likely to transpire fast and with no warning.”
The pandemic was “perversely” positive for big corporations, 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 strategies as well as scale “to evolve as well as preserve their earnings.” As a result, Crisafulli agrees that rates should 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 actually spending each month buying back Treasurys and mortgage-backed securities after initiating a substantial $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 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 noted that the central bank was open to adjusting its rate of purchases when springtime hits. “Economic agents should be prepared for a period of very low interest rates as well as an expansion of our stability sheet,” Evans said.
What 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 far more closely with the Fed to help battle economic inequalities through programs like universal standard income, Morgan Stanley notes. “That is exactly the sea of change which may result in unexpected outcomes in the financial markets,” the investment bank says.