Unprecedented spending by each lawmakers and 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 concerned that the unintended consequences of pent-up demand and more dollars when the pandemic subsides could tank markets this year-quickly and abruptly.
Dow Plunges Despite Fed Buyout Plan for Debt Traders focus on the floor of the new York Stock Exchange.
The most significant market surprise of 2021 may be “higher inflation than 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 simply filling gaps left by crises and it is as an alternative “creating newfound spending that led to the fastest economic recovery on record.”
By using its money reserves to pay for back some $1 trillion in securities, the Fed has created a market that’s awash with cash, which usually helps drive inflation, and Morgan Stanley warns that influx might drive up prices as soon as the pandemic subsides and companies scramble to meet pent up consumer demand.
Within the stock market, the inflation risk is actually greatest for industries “destroyed” by the “ill-prepared and pandemic for what might 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 made to drive up prices if they are unable to cover post-Covid demand.
The best inflation hedges in the medium-term are actually commodities as well as stocks, the investment bank notes, but inflation may be “kryptonite” for longer term bonds, which would eventually have a short-term negative influence on “all stocks, should that adjustment occur abruptly.”
Ultimately, Morgan Stanley estimates firms in the S&P 500 may 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 current market fundamentals-an enhance the analysts said is actually “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 fourteen % gain last year.
“With global GDP output already back to the economy and pre-pandemic levels not yet even close to completely reopened, we imagine the risk for much more acute price spikes is higher compared to appreciated,” Morgan Stanley equity strategists led by Michael J. Wilson said, noting that the quick rise of bitcoin as well as other cryptocurrencies is an indicator markets are today choosing to consider currencies like the dollar could be in for a surprise crash. “That adjustment of rates is just a question of time, and it is more likely to transpire quickly and without 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 federal government spending utilized existing methods as well as scale “to evolve and save their earnings.” As a result, Crisafulli believes 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 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 several $3.5 trillion in spending to shore up the economic recovery as a consequence of the pandemic.
Chicago Fed President Charles Evans said Monday he’d “full confidence” the Fed was well-positioned to help spur a robust economic recovery with its present asset purchase plan, and he further noted that the central bank was ready to accept adjusting its rate of purchases when springtime hits. “Economic agents should be prepared for a period of suprisingly low interest rates and 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 sign the federal government might work far more closely with the Fed to assist battle economic inequalities through programs including universal basic income, Morgan Stanley notes. “That is just the ocean of change that can lead to unexpected results in the financial markets,” the investment bank says.