The end of the party is looming for strongly stimulated markets
The writer, the global chief strategist of Morgan Stanley Investment Management, is the author of “ Ten Rules of Successful Nations ”
It was a shocking picture. As deaths from the pandemic increased in 2020, financial markets, led by the government, experienced a devastating global recession. Most people expect the celebrations to continue as the economy recovers. But now there are signs the recovery could turn into a boom – and an overheated economy could end the market. This year could play out like a mirror image of 2020, with stagnant markets amid soaring economic growth.
To understand why, follow the money. After a brief crash last March, markets have started to recover the day after the announcement by the US Federal Reserve of its first pandemic relief measures – and continued to rally. Almost 20% of all dollars in circulation were printed in 2020 alone. The big central banks followed the Fed, and governments supplemented that with stimulus spending. Income available in the United States has grown at the fastest rate in decades, but much has not been spent. Americans saved at the highest rate since World War II, saving an additional $ 1.7 billion, or more than 16 percent of their 2020 income.
With more money in the bank and more free time due to lockouts, many workers turned to the boat on the stairs. Of 49 million online brokerage accounts in the United States, 13 million were opened in 2020, according to calculations by Scott Rubner of Goldman Sachs. In the week following the stimulus checks in April, trade among middle-class Americans soared.
U.S. retail investors have helped fuel whirlwind fads for bankrupt companies like JC Penney, and more recently for another failed retailer, GameStop. From South Korea to India, individuals have been buying stocks at a breakneck pace. The big winners have been the big growth stocks, particularly in the United States and China. Together they accounted for most of the market gains in 2020 globally.
Where will all the money go when the virus goes away? Epidemiologists say the pandemic could be contained by summer, possibly even spring in the United States and the United Kingdom, where vaccines are rapidly being rolled out. As consumers emerge from lockdown, excess savings are likely to drop sharply. Even by conservative estimates, the release of pent-up demand could add two to three percentage points to gross domestic product growth in the United States alone.
The consensus prediction for global GDP growth in 2021, it is a little more than 5%. But my team thinks the growth could be as high as 6% globally and as high as 8% in the United States. I think other forecasters are underestimating the recovery, given the glut of savings and the apparent eagerness of policymakers to be mistaken by too much stimulation. Ironically, a booming economy may not be good for the markets. Savers will become buyers again. The resumption in demand for leisure travel, dining and other services will strain the capacity of industries ravaged by the pandemic.
The deflationary impact of business closures could give way to the potentially inflationary impact of supply shortages, already visible in sectors such as expedition, Airlines companies and semiconductors. The prices of basic products soybean oil have also increased in recent times.
The bond market is starting to integrate higher inflation, and the prospect of higher yields could suck money out of stocks, which are now much more vulnerable to interest rate fluctuations. Equity valuations received an unusually large boost last year due to falling rates. A large increase would cause a correspondingly large shock. In addition, the rally was mainly driven by growth stocks – the type most sensitive to changes in interest rates – and they now dominate many stock market indices.
Higher long-term interest rates could end the extraordinary bull run of giant tech stocks in the United States and China and shift flows to a new set of countries and industries. The buzzwords of the past year – virus, virtual, work from home, recession – should make way for vaccines, the real world, returning to the office and reflation. This transition may be more disruptive than imagined for financial markets, which became addicted to last year’s themes and low long-term interest rates.
Markets often underestimate the impact of big changes in the global economy. In the early 1980s, disinflation caused interest rates to drop sharply, with much bigger fallout in the markets than most investors anticipated. Now the risk is that inflation will resurface and bond yields rise more sharply than expected, crushing rising earnings during a rally. The impact could easily end the 2020 rally, leaving markets to suffer symptoms of pullback despite a global economic boom.