Morgan Stanley
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Is This Recession Actually… Normal?

With Andrew Sheets

While the macro events of the last few months are certainly extreme by the standards of history, the current business cycle may be more normal than is appreciated.

Each week, Chief Cross-Asset Strategist Andrew Sheets, or a member of his team, offers perspective on the forces shaping the markets as well as insights on investment opportunities and risk across global asset classes.

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Current Episode Transcript

Welcome to Thoughts in the Market. I'm Andrew Sheets, Chief Cross Asset Strategist for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape and how we put those ideas together. It's Friday, June 19th, at 2p.m. in London.

Twice a year, Morgan Stanley's economists and strategists around the world come together to reset, debate, and forecast what we think the next 12 months could look like. We've just concluded the most recent iteration, debated against a backdrop of a global health emergency, a decline in economic activity, and a level of policy response that are all extreme by the standards of history. Here is what we expect going forward.

The first question that needs to be addressed is, "do these extreme events that we're seeing at the moment scramble our usual market indicators?" Can historical analysis of what's happened during prior recessions still apply, given the scale of what's going on at the moment? This is an important debate, but we do think those old rules still apply. Indeed, we continue to think that this current cycle is much more normal than is appreciated.

Why is that? Well, first, the conditions that existed at the start of this year shared many normal late cycle characteristics that preceded other recessions: low unemployment, rising inflation, high market valuations, low volatility, confident consumers, and an inverted yield curve, just to name a few. Secondly, the way the current market bottomed in March relative to the lows of economic data was also quite normal and similar to prior recessions. And third, maybe most importantly, our economists at Morgan Stanley think the post recession recovery will look relatively normal, with growth recovering to prerecession levels about twice as fast as what followed the global financial crisis.

This growth profile is a key part of our outlook for the next 12 months. We think the economy won't return to pre-coronavirus levels until the end of next year. But given current low market expectations, we think that pace of expansion-- a further 18 months before conditions go back to where they were before the recession started-- mean we're actually more optimistic than the market on U.S. and global growth.

Going forward, we think that means we're in what we'd call an "early cycle market," where economic growth is weak but starting to improve, when central bank support for the economy is intense, and when investors are often quite nervous given the economic weakness that they see all around them. Such periods often show similar patterns as economic expectations rise from low levels: credit spreads and volatility decline, yields and inflation expectations rise, yield curves steepen, the U.S. dollar weakens, and smaller, more cyclical stocks finally begin to outperform. We think all will happen going forward and all are supported by attractive relative valuations.

What are the risks to this view? Well, near-term, we're watching three events over the summer. First, will U.S. Covid-19 cases, still arguably in their first wave, rise further? Secondly, is our expectation that July will see two positive policy events, a further U.S. economic relief package and further movement on the European recovery fund, too optimistic? And third, will a looming U.S. election act as a brake on markets as it's done in several recent election years? All are risks that we're watching, but we don't think they change the story. This recession has ended one business cycle and started a new one, and we think investors should position as such.

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