The risk of a hard landing is growing, says Morgan Stanley
Throughout January, the stock market rallied as investors began pricing in a “soft landing” for the economy — forecasting that the Federal Reserve would be able to tame inflation without triggering a recession. But Morgan Stanley Wealth Management chief investment officer Lisa Shalett warned Tuesday that “looking through the fog” to hint at a new bull market is a bad idea.
After the US economy added more than half a million jobs last month, pushing the unemployment rate to a 53-year low of 3.4% and retail sales rising 3%, beating economists’ expectations, fears are looming Shalett said the Fed needs to keep interest rates “higher for longer” to cool the economy and contain inflation.
“As consumption and inflation reheat, the risk of a boom/bust-like hard landing increases, even if the pain is delayed by a quarter or two,” she warned in a statement Tuesday.
Recent strength in consumer spending and the labor market, along with better-than-expected corporate earnings, have led many investors to believe equities are headed for a “Goldilocks scenario” — in which the economy is neither too hot nor too cold and valuations remain elevated. But Shalett said that will only work if inflation continues to fall. And the latest Consumer Price Index (CPI) and Producer Price Index (PPI) data no longer show “rapidly declining inflation,” according to the CIO.
Although year-on-year CPI inflation fell to 6.4% in January from a 40-year high of 9.1% in June, it is still well above the Fed’s target rate of 2%. And PPI inflation — which measures changes in wholesale prices for businesses — was also 6% last month, showing price increases could be permanent.
Shalett warned that this data means that with rate hikes in 2023, Fed officials will face “even more pressure to cool demand,” noting that consumer inflation expectations also rose this month. Economists are watching inflation expectations carefully for signs that rising prices have become entrenched in consumer psyches, making them harder to combat.
That means investors who are betting on a “Fed put” — or a quick return to low interest rates as inflation cools — “are probably wrong this time around,” Shalett said.
“We caution that recent gains appear extremely fragile,” she added. “The Fed’s credibility is at stake and it’s likely to risk overshooting rather than ending the inflation fight too soon.”
Morgan Stanley’s base case calls for the S&P 500 to end the year at 3,900 points, or about 2.5% below current levels, but the bank’s analysts believe it won’t be a straight road there. The index could fall as low as 3,000 this year before recovering.
Shalett cautioned against “buying the dip” in this environment, recommending investors focus on stocks that offer dividends and have strong free cash flows in these turbulent markets.
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