Unprecedented spending by each 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 consultants are worried that the unintended effects of extra dollars and pent-up demand when the pandemic subsides could very well tank markets this year-quickly and abruptly.
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Crucial FACTS
The largest market surprise of 2021 may be “higher inflation compared to many, 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 simply filling gaps left by crises and it is rather “creating newfound spending that led to the fastest economic recovery on record.”

By making use of its cash reserves to buy back some $1 trillion in securities, the Fed has produced a market that is awash with cash, which usually helps drive inflation, along with Morgan Stanley warns that influx might drive up prices when the pandemic subsides and organizations scramble to satisfy pent-up customer 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 as well as other customer in addition to business related firms which could be forced to drive up prices if they are unable to meet post-Covid demand.

The best inflation hedges in the medium term are actually 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 impact on “all stocks, must that adjustment take place abruptly.”

Ultimately, Morgan Stanley estimates firms in the S&P 500 could 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 increase the analysts said is actually “unlikely” but shouldn’t be entirely 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 as opposed to the index’s fourteen % gain last year.

Crucial QUOTE
“With worldwide GDP output already back to pre-pandemic levels as well as the economy not yet actually close to fully reopened, we imagine the risk for much more acute price spikes is actually greater 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 a sign markets are right now beginning to consider currencies prefer the dollar can be in for a surprise crash. “That adjustment in rates is just a situation of time, and it is likely to transpire fast and without warning.”

KEY BACKGROUND
The pandemic was “perversely” positive for big companies, Crisafulli said Monday. The S&P’s fourteen % gain pales in comparison to the tech-heavy and larger Nasdaq‘s eye-popping 40 % surge last year, as firms-boosted by federal government spending-utilized existing resources and scale “to develop as well as preserve their earnings.” As a result, Crisafulli concurs that rates needs to be the “big macroeconomic story of 2021” as a waning pandemic unearths upward price pressure.

Large NUMBER
$120 billion. That is how much the Federal Reserve is spending every month buying back Treasurys and mortgage-backed securities following initiating a massive $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 result of the pandemic.

CHIEF CRITIC
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 even further mentioned that the central bank was open to adjusting its rate of purchases once springtime hits. “Economic agents must be equipped for a period of really 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 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 precisely the ocean of change which may result in unexpected results in the fiscal markets,” the investment bank says.