Should investors start to prepare for recession?
Morgan Stanley Wealth Management05/18/22
Summary: The odds of a recession in the next year are rising. What investors should keep in mind.
Investors have had a lot to digest over the past six months: high and sustained inflation, an accelerated pivot toward tighter monetary policy, Russia’s invasion of Ukraine—and big selloffs in both stocks and bonds related to these headwinds.
And while post-pandemic economic tailwinds and the resilience of corporate earnings have provided some hope that the Federal Reserve can engineer a “soft landing” for the economy, Morgan Stanley’s Global Investment Committee (GIC) is less optimistic.
In fact, Morgan Stanley’s proprietary recession indicator is now indicating a 27% chance of a recession in the next 12 months, up from just 5% in March.
What may be behind this:
1. Inflation persists.
Recently released inflation data showed year-over-year consumer price gains of 8.3% in April—down slightly from 8.5% in March, but still higher than consensus estimates of 8.1%. “Core” inflation, which excludes more-volatile food and energy items, rose 0.6% over the month, also above expectations.1 Drivers behind the rise were “sticky” items whose prices may remain stubbornly high, such as medical care and rent. The basic implication is that inflation is now broadening out, with the potential for it to stay higher for longer—historically, a scenario that keeps the Fed in policy-tightening mode.
2. Price pressures may lead to "demand destruction."
Higher prices may eventually cause consumers to forgo purchases they would have otherwise made. There are signs of slowing demand in sectors that typically do well early in an economic cycle, such as housing and autos. On the supply side, inventory-rebuilding has been strong and may now start to slow. This means consumer demand may cool at a time when inventories have already been restocked, leading to an imbalance that could hurt businesses. In fact, the Morgan Stanley & Co. US Economics team just cut its full-year GDP growth estimate by a full percentage point to 2.6%.
3. Commodity- and currency-market volatility complicates the global growth outlook.
Turmoil in stock and bond markets has now spilled over into commodities and currencies, casting a shadow over global growth prospects and fueling uncertainty in other markets. With commodity prices still relatively high, business and financial conditions are improving for emerging markets that are significant commodity exporters, while worsening for importers. These dynamics are intensified by a simultaneous strengthening of the US dollar, which makes it relatively more expensive for some emerging market countries and businesses to pay their dollar-denominated debts.
These developments mean conditions are ripening for a cyclical bear market—a period during which stock and bond prices correct to reflect an environment of more risk, less liquidity, higher rates, and lower price multiples, as well as more-sober earnings expectations.
While this may sound ominous, it’s important to keep things in perspective. After all, markets have experienced these types of corrections and downturns over the course of history. Most cyclical bear markets are brief—including the last one in March 2020.
Letting panic-inducing headlines influence investment decisions in a “risk-off” environment can end up doing more harm than good. For long-term investors, it’s important to stay the course and keep portfolios aligned to individual goals, timelines, and risk tolerance.
Morgan Stanley disclosures
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