There’s more to this market than the Fed’s next move
Morgan Stanley Wealth Management09/08/22
Summary: Dynamics other than the Federal Reserve’s ongoing inflation fight are having an impact on investors’ portfolios. Risks and opportunities to watch.
For most of 2022, investors have seemed narrowly focused on the direction of Federal Reserve policy. Given the level of inflation we’ve seen, and the outsized role that monetary policy has played in driving market outcomes since 2008, this is understandable.
But there’s more to consider in the current market than the Fed and its fight against inflation. Lisa Shalett, Morgan Stanley Wealth Management’s Chief Investment Officer, sees other important dynamics in play that may affect investment portfolios.
Today’s corporate earnings forecasts appear unrealistically high, especially given recent re-affirmation from Fed Chair Jerome Powell of the central bank’s commitment to fighting inflation—even if it means inflicting some pain on the economy and corporate profits.
Consensus earnings expectations have come down a bit, but estimates for 2023 are still up 5% over 2022, and Morgan Stanley expects another leg down, of about 10%-15%. Corporate executives and Wall Street analysts may be underestimating the potential loss of pricing power that companies will experience with further rate cuts and falling inflation. Shifts in consumer spending from goods to services may weigh on some sectors that have thrived during the pandemic, including retail, consumer goods, and automotive. Finally, of course, the broad economic slowdown will likely have widespread effects.
Although the risks of the Russia/Ukraine war and implications to energy and food prices may be well known, other global dynamics may be less appreciated.
First, the situation in Europe bears watching. The energy crisis is getting worse, with natural gas and electricity prices soaring. This has pushed up eurozone inflation and raised the probability of a recession in Europe. Indeed, markets seem to have factored in this outcome, reflected in the euro’s weakness against the US dollar and 12-year-low equity valuations relative to US stocks. With recession risk likely priced in, though, this may mean potential longer-term opportunities for value-oriented investors.
In China, the economic situation may actually be the reverse of Europe’s. While negative headlines about lingering COVID shutdowns may persist, upcoming political elections could set the stage for what’s likely to be a string of economic stimulus programs. And, unlike other major markets, China’s low inflation gives the country plenty of policy flexibility.
Investors would be wise to look beyond just the Fed. With other dynamics and risks in play, diversifying portfolios across countries and regions can help investors reduce risk and broaden exposure to potential growth opportunities. In the near term, valuations for stocks outside of the US appear more compelling than those for domestic equities. And in 2023, non-US markets likely present more potential for upside surprises.
The source of this Morgan Stanley article, There’s More to This Market Than the Fed’s Next Move, was originally published on September 7, 2022. Data and claims are based on the Global Investment Committee Weekly report from September 6, 2022, “Global Complications.”
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