- Lisa Shalett, CIO of wealth management at Morgan Stanley, said in a statement last week that stock investors have been overly optimistic.
- She argued that recent strength in stocks could be a bear market rally fueled by “wishful thinking” and excess liquidity.
- Shalett identified three risks, including Fed policy tightening, higher interest rates and macroeconomic headwinds.
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Investors should be wary of stock market stability after recent lows, says CIO of Morgan Stanley’s wealth management division.
“Recent strength in the stock market may be nothing more than a
bear market
Rally fueled by wishful thinking and excess
liquidity
‘ Lisa Shalett wrote in a recent report.
Despite a difficult week, global stock indexes are still significantly higher from recent lows, with the S&P 500 and the tech-heavy Nasdaq 100 gaining more than 3% over the past month. But both benchmarks are still heavily down for the year as investors grapple with sky-high inflation, skyrocketing commodity prices and a series of rapid US interest rate hikes.
Schallett said the gains so far in April were driven by investor hopes
federal reserve
would bring about a “soft landing” by raising interest rates fast enough to cool inflation but without sending the economy into crisis
recession
.
The Fed hiked interest rates in March for the first time since 2018, taking a big step to tame US inflation from its highest level in 40 years and planning a series of at least six more rate hikes this year. Markets are pricing in expectations for a 50 basis point hike from the next Fed meeting in May and possibly more at subsequent meetings.
The Fed is also expected to shrink its balance sheet by $95 billion a month, according to the latest meeting minutes. Futures markets show that investors believe US rates could be at 2.75% by the end of this year, compared to the current 0.5%.
Shalett said she disagrees with the view that investors seem to believe the Fed’s rate hikes will not affect stock valuations and that they are ignoring macroeconomic risks from the Russia-Ukraine war and slowing growth.
“Morgan Stanley’s Global Investment Committee disagrees with these optimistic views and believes that some of the more cautious signals coming from the bond market may better reflect the likely path forward,” she said.
First, she said the Fed is expected to hike rates more frequently than the market expected three months ago and cut more billions than expected from its asset holdings each month.
“Such aggressive tightening will make Fed policy implementation very complex, and historical examples suggest that even if the central bank manages to gently stimulate the economy, markets often feel a much harsher impact,” she said.
She believes investors are underestimating the potential impact of a series of rapid rate hikes on the stock market and the impact they will have on the underlying economy.
“This may be wishful thinking. We believe the Fed will tend to tighten more than many investors expect, which will affect real interest rates and valuations as a result,” she said.
Finally, Shalett said that input costs, including wages, are still rising for companies, US growth will slow, and there is a real risk of recession in Europe due to the Russian war in Ukraine, especially if the single currency bloc halts Russian energy imports .
With that in mind, 2020 and 2021’s double-digit gains will be more difficult to achieve, she said.
“As financial conditions tighten, a strong but slowing economy probably won’t be enough to generate significant passive index gains from here,” she said.
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