Morgan Stanley
  • Wealth Management
  • May 4, 2021

Supply-Chain Woes Could Weigh on Markets

Amid strong economic growth and new stock-market highs, reasons for concern have begun to materialize. Emerging supply-chain imbalances stand out as a risk.

Lisa Shalett Chief Investment Officer, Wealth Management

As is often the case with bull markets, a lengthy run of good news and better-than-expected economic data has helped propel stocks to all-time highs. Investor risk-taking has increased, and confidence has begun turning into complacency. Now, new risks are emerging. Key among them: mounting supply-chain woes that are making it harder for businesses to keep up with soaring demand.

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These pressures come as a faster-than-expected vaccine rollout in the U.S. is helping drive stronger economic growth, with states like New York and California targeting July 1 for full reopening. The supply-chain imbalances are becoming so severe that their risks go beyond the short-lived bout of inflation that many analysts predicted. Rising real-time production delays could crimp sales and drag down corporate earnings and economic growth.

With 2021’s first-quarter earnings season well underway, references to inflation and supply-chain pressures on company conference calls have been triple the average of the past decade.1 Some corporate executives say that they may have to curtail production due to a lack of semiconductors and electronic components. That could also slow the labor market’s recovery.

Supply-chain pressures aren’t the only concerns. In the weeks and months ahead, investors may also want to be cautious about: 

  • Soaring home prices: The imbalance between pent-up demand and available inventory isn’t just an industrial problem. With existing housing inventory at historic lows and home prices appreciating at an eye-popping 12% annualized rate,2 the pace of new mortgage applications has slowed, as more would-be homebuyers get priced out. This decline in housing affordability could stall one of the most important engines of U.S. economic growth.
  • High levels of margin debt: One manifestation of investors’ increased risk appetite has been the recent rise in margin debt, or money borrowed from financial institutions to buy securities. Margin debt has grown 72% year-over-year to levels that have often preceded stock-market declines.
  • Policy headwinds: Policy could become a headwind this fall, as Federal Reserve officials begin to discuss a timetable for tapering bond purchases and Congress debates tax and stimulus plans.

Consider that positive economic surprises and the pace of earnings forecast revisions may be peaking. As such, investors may want to begin slowing their deployment of cash into U.S. equities, while they await better entry points into the market, such as a resumption of positive earnings revisions or a U.S. market correction. We also suggest favoring non-U.S. stocks over the next six to nine months.

This article is based on Lisa Shalett’s Global Investment Committee Weekly report from May 3, 2021, “Peak Everything.” Ask your Financial Advisor for a copy or find an advisor. Listen to the audiocast based on this report. 

1 Source: Bloomberg as of March 31, 2021

2 Source: S&P CoreLogic Case-Shiller Indices; latest data is for February 2021, released Apr 27, 2021

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.

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