Morgan Stanley
  • Wealth Management
  • Jun 22, 2020

Four Ds That Could Drive the Next U.S. Economic Cycle

In the wake of COVID-19 disruptions, important economic shifts lie ahead, which investors should position their portfolios for now.

Lisa Shalett Chief Investment Officer, Wealth Management

When considering the current U.S. economic outlook, the main forces shaping the future can be summed up neatly using four words, all of which start with the letter D. 

Manage your Wealth

Find a Financial Advisor, Branch and Private Wealth Advisor near you

I’ll cover each of them, but the key thing for investors to understand is that these trends, hastened to some extent by the impact of COVID-19, all point to potential inflation (no, “deflation” isn’t on this list). Here are the four:

  • Demographics: The impact of Baby Boomers on the workforce continues to recede, as Millennials and Gen Z are being hired at an accelerating rate. COVID-19 may speed up this transition, leading more Boomers to retire and creating opportunities for Millennials to move up. This dynamic could result in a wealth transfer that fuels spending, just as Millennials, the oldest of whom are now nearing 40, are buying homes and otherwise reaching their prime spending years. This dynamic could allow consumer prices to rise.
  • Deglobalization: In the past decade, globally optimized supply chains—as well as a 20-year high in the strength of the dollar against other major currencies, such as the euro, pound and yen—helped to check price inflation. Recent trade conflicts, mainly between the U.S. and China, had already started to slow the march toward a global economy. Now, the coronavirus pandemic has likely sped up this shift toward deglobalization, as national concerns about safety and security are at the forefront. Returning supply chains to the U.S. may mean more opportunities for many small-cap and mid-cap U.S. businesses, but would likely contribute to consumer price inflation.
  • Deficits: Federal debt and deficits are exploding in the wake of COVID-19 disruptions. Unlike the financial crisis of 2008, when much of the growth in the money supply ultimately went into financial assets, this time, fiscal stimulus is focused on individuals and small businesses. That way, any excess funds can be reinvested in the real economy, not just capital markets. With the Fed essentially buying all the new government debt, such dramatic growth in the money supply is clearly inflationary.
  • Dollar debasement: It’s economics 101 that a rise in U.S. inflation inevitably leads to a decline in the value of the dollar (and vice versa). As I discussed recently, I expect the current level of monetary intervention to cause the dollar to weaken. If the Fed applies more stimulus to keep long- and short-term rates low, it will likely drive inflation through U.S. dollar debasement.

I expect these reflationary dynamics to lead to sector rotation toward cyclicals and away from the secular growth and defensive stocks that dominated the past business cycle. This dynamic has been on hiatus since the early June Fed meeting, which was surprisingly downbeat, but I expect the trend to reassert itself in the coming weeks.

Meantime, I advise investors to diversify across sectors, while balancing exposures to small-caps and large-caps, U.S. and international stocks, and growth and value investing styles, while keeping an eye out for an upside surprise in inflation expectations.

This article is based on Lisa Shalett’s Global Investment Committee Weekly report from June 22, 2020, “Deflation and the Four Ds.” Ask your Financial Advisor for a copy or find an advisor.  Listen to the audiocast based on this report. 

Risk Considerations

Yields are subject to change with economic conditions. Yield is only one factor that should be considered when making an investment decision. 

Equity securities may fluctuate in response to news on companies, industries, market conditions and general economic environment.

Bonds are subject to interest rate risk. When interest rates rise, bond prices fall; generally the longer a bond's maturity, the more sensitive it is to this risk. Bonds may also be subject to call risk, which is the risk that the issuer will redeem the debt at its option, fully or partially, before the scheduled maturity date. The market value of debt instruments may fluctuate, and proceeds from sales prior to maturity may be more or less than the amount originally invested or the maturity value due to changes in market conditions or changes in the credit quality of the issuer. Bonds are subject to the credit risk of the issuer. This is the risk that the issuer might be unable to make interest and/or principal payments on a timely basis. Bonds are also subject to reinvestment risk, which is the risk that principal and/or interest payments from a given investment may be reinvested at a lower interest rate.

Asset allocation and diversification do not assure a profit or protect against loss in declining financial markets.

Rebalancing does not protect against a loss in declining financial markets.  There may be a potential tax implication with a rebalancing strategy.  Investors should consult with their tax advisor before implementing such a strategy.

Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies.  Technology stocks may be especially volatile.

International investing entails greater risk, as well as greater potential rewards compared to U.S. investing. These risks include political and economic uncertainties of foreign countries as well as the risk of currency fluctuations. These risks are magnified in countries with emerging markets, since these countries may have relatively unstable governments and less established markets and economies.

Investing in foreign emerging markets entails greater risks than those normally associated with domestic markets, such as political, currency, economic and market risks.

Investing in commodities entails significant risks. Commodity prices may be affected by a variety of factors at any time, including but not limited to, (i) changes in supply and demand relationships, (ii) governmental programs and policies, (iii) national and international political and economic events, war and terrorist events, (iv) changes in interest and exchange rates, (v) trading activities in commodities and related contracts, (vi) pestilence, technological change and weather, and (vii) the price volatility of a commodity. In addition, the commodities markets are subject to temporary distortions or other disruptions due to various factors, including lack of liquidity, participation of speculators and government intervention.

Certain securities referred to in this material may not have been registered under the U.S. Securities Act of 1933, as amended, and, if not, may not be offered or sold absent an exemption therefrom.  Recipients are required to comply with any legal or contractual restrictions on their purchase, holding, and sale, exercise of rights or performance of obligations under any securities/instruments transaction.

Disclosures

Morgan Stanley Wealth Management is the trade name of Morgan Stanley Smith Barney LLC, a registered broker-dealer in the United States. This material has been prepared for informational purposes only and is not an offer to buy or sell or a solicitation of any offer to buy or sell any security or other financial instrument or to participate in any trading strategy.  Past performance is not necessarily a guide to future performance.

The author(s) (if any authors are noted) principally responsible for the preparation of this material receive compensation based upon various factors, including quality and accuracy of their work, firm revenues (including trading and capital markets revenues), client feedback and competitive factors.  Morgan Stanley Wealth Management is involved in many businesses that may relate to companies, securities or instruments mentioned in this material.

This material has been prepared for informational purposes only and is not an offer to buy or sell or a solicitation of any offer to buy or sell any security/instrument, or to participate in any trading strategy. Any such offer would be made only after a prospective investor had completed its own independent investigation of the securities, instruments or transactions, and received all information it required to make its own investment decision, including, where applicable, a review of any offering circular or memorandum describing such security or instrument.  That information would contain material information not contained herein and to which prospective participants are referred. This material is based on public information as of the specified date, and may be stale thereafter.  We have no obligation to tell you when information herein may change.  We make no representation or warranty with respect to the accuracy or completeness of this material.  Morgan Stanley Wealth Management has no obligation to provide updated information on the securities/instruments mentioned herein.

The securities/instruments discussed in this material may not be suitable for all investors.  The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives.  Morgan Stanley Wealth Management recommends that investors independently evaluate specific investments and strategies, and encourages investors to seek the advice of a financial advisor. The value of and income from investments may vary because of changes in interest rates, foreign exchange rates, default rates, prepayment rates, securities/instruments prices, market indexes, operational or financial conditions of companies and other issuers or other factors.  Estimates of future performance are based on assumptions that may not be realized.  Actual events may differ from those assumed and changes to any assumptions may have a material impact on any projections or estimates. Other events not taken into account may occur and may significantly affect the projections or estimates.  Certain assumptions may have been made for modeling purposes only to simplify the presentation and/or calculation of any projections or estimates, and Morgan Stanley Wealth Management does not represent that any such assumptions will reflect actual future events.  Accordingly, there can be no assurance that estimated returns or projections will be realized or that actual returns or performance results will not materially differ from those estimated herein. 

This material should not be viewed as advice or recommendations with respect to asset allocation or any particular investment. This information is not intended to, and should not, form a primary basis for any investment decisions that you may make. Morgan Stanley Wealth Management is not acting as a fiduciary under either the Employee Retirement Income Security Act of 1974, as amended or under section 4975 of the Internal Revenue Code of 1986 as amended in providing this material except as otherwise provided in writing by Morgan Stanley and/or as described at www.morganstanley.com/disclosures/dol.

 

Morgan Stanley Smith Barney LLC, its affiliates and Morgan Stanley Financial Advisors do not provide legal or tax advice.  Each client should always consult his/her personal tax and/or legal advisor for information concerning his/her individual situation and to learn about any potential tax or other implications that may result from acting on a particular recommendation.

 

This material is disseminated in Australia to “retail clients” within the meaning of the Australian Corporations Act by Morgan Stanley Wealth Management Australia Pty Ltd (A.B.N. 19 009 145 555, holder of Australian financial services license No. 240813).

Morgan Stanley Wealth Management is not incorporated under the People's Republic of China ("PRC") law and the material in relation to this report is conducted outside the PRC. This report will be distributed only upon request of a specific recipient. This report does not constitute an offer to sell or the solicitation of an offer to buy any securities in the PRC. PRC investors must have the relevant qualifications to invest in such securities and must be responsible for obtaining all relevant approvals, licenses, verifications and or registrations from PRC's relevant governmental authorities.

If your financial adviser is based in Australia, Switzerland or the United Kingdom, then please be aware that this report is being distributed by the Morgan Stanley entity where your financial adviser is located, as follows: Australia: Morgan Stanley Wealth Management Australia Pty Ltd (ABN 19 009 145 555, AFSL No. 240813); Switzerland: Morgan Stanley (Switzerland) AG regulated by the Swiss Financial Market Supervisory Authority; or United Kingdom: Morgan Stanley Private Wealth Management Ltd, authorized and regulated by the Financial Conduct Authority, approves for the purposes of section 21 of the Financial Services and Markets Act 2000 this material for distribution in the United Kingdom.

Morgan Stanley Wealth Management is not acting as a municipal advisor to any municipal entity or obligated person within the meaning of Section 15B of the Securities Exchange Act (the “Municipal Advisor Rule”) and the opinions or views contained herein are not intended to be, and do not constitute, advice within the meaning of the Municipal Advisor Rule.

This material is disseminated in the United States of America by Morgan Stanley Smith Barney LLC.

Third-party data providers make no warranties or representations of any kind relating to the accuracy, completeness, or timeliness of the data they provide and shall not have liability for any damages of any kind relating to such data.

This material, or any portion thereof, may not be reprinted, sold or redistributed without the written consent of Morgan Stanley Smith Barney LLC.

© 2020 Morgan Stanley Smith Barney LLC. Member SIPC.

CRC#3134826 (06/2020)

View disclosures