Morgan Stanley
  • Wealth Management
  • Feb 1, 2021

Keep Your Eyes on the Economic Recovery

Investor anxieties about the pandemic, partisanship and policy have fueled market swings, but retreating to 2020’s big-tech winners may not be the solution.

Lisa Shalett Chief Investment Officer, Wealth Management 

January was a tumultuous month for U.S. markets. While technically speaking, the broader market S&P 500 index ended the month slightly lower, the real significance lies in the market’s retreat from cyclical sectors that define an economic recovery—such as financials, small caps, energy and industrials, down around 8%—back to big tech winners, many associated with the “work from home” theme, up nearly 3% for the year.

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This reversion will likely prove temporary. Longer term, we believe that the economic recovery and reflation scenario will stay on track, despite investor concerns over recent bouts of stock market volatility.

Here’s a look at three areas of doubt for investors and why we remain optimistic for the year: 

  • Anxiety over the slower-than-expected pace of vaccinations may be overblown. A successful vaccine rollout plays a critical role in fully reopening the U.S. economy by the second half of 2021. Nearly 24 million shots have been given in the U.S. and the rollout has accelerated. Plus, nationwide, daily new infections, hospitalizations and fatalities have all started to decline steadily, giving hope that the U.S. may be turning a meaningful corner, despite the appearance of new coronavirus variants.
  • The Federal Reserve could reverse its dovish policy stance, but that seems unlikely. Could inflationary pressures force the Fed to reign in its robust monetary stimulus? We view last week’s Fed updates as unequivocally dovish, with its commitment to keep injecting liquidity via its $120-billion-a-month bond-buying program unchanged. Tellingly, Fed Chair Jerome Powell said that “the bar was extremely high” to convince the Fed that it needs to worry about inflation expectations. Indeed, Morgan Stanley & Co. Chief U.S. Economist Ellen Zentner doesn’t believe that the Fed will even discuss scaling back on stimulus before the end of 2021, at the earliest.
  • Congress could fail to pass more stimulus, but we think it will succeed. The latest partisan infighting may slow additional federal funds to battle the pandemic and boost the economy, adding to investors’ more defensive mood. Still, we believe that the probability for at least another $1 trillion in COVID-19-related stimulus between March and May remains high. Investors’ patience will likely be rewarded.

To be sure, vaccine distribution logistics and new variants of COVID-19 pose risks to the recovery. However, we believe that retreating to the overvalued, tech-heavy side in the S&P 500 could prove more costly.

As long as the pace of the vaccine rollout accelerates through March, the second-half economic rebound will likely stay on track. Indeed, the uptick in volatility could present investors with opportunities to take up selective positions in cyclical businesses with strong valuation support that stand to benefit from the recovery. These include sectors such as financials, industrials, consumer discretionary and energy.

This article is based on Lisa Shalett’s Global Investment Committee Weekly report from Feb 1, 2021, “Game Time.” 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.

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