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According to Morgan Stanley, investors most recently drew hope for an imminent change of course by the world’s most powerful central bank from declining inflation rates, whereupon the S&P 500 rallied more than 14% within two months. But the focus of market participants is now likely to shift away from the Fed’s monetary policy and interest rates. Instead, from now on, it will increasingly be on the consumer, who could come under increasing pressure in the coming year, mainly because of the Fed’s aggressive tightening, the U.S. bank warned in a note published on Monday.
“The U.S. economy is likely to start feeling the effects of this year’s policy tightening in earnest in 2023, since the economic effects of changes in monetary policy tend to lag by about six to 12 months,” says Lisa Shalett, chief investment officer of wealth management at Morgan Stanley.
For 2023, Morgan Stanley expects weak GDP growth. As a result, sales volumes, pricing power, and corporate profits will suffer, the expert said. “Yet current earnings expectations and stock valuations don’t seem to reflect this outlook,” Shalett warns.
Going forward, she advises investors to focus more intently on the consumer and less on the Fed interest rate path. According to current market estimates, interest rates are likely to peak at 5.0% to 5.25% next July.
The U.S. economy is heavily consumer-driven. As Shalett writes, consumption accounts for two-thirds of U.S. economic activity, which “will likely determine the timing and depth of the economic slowdown.”
According to the New York Fed’s model, the U.S. economy has a 38% probability of falling into recession in November 2023. Because of the model’s accuracy in the past, once it indicates a value above 30%, the probability is probably closer to 100%.
The U.S. consumer is “likely to influence the timing of actual interest-rate cuts, which historically have been a more reliable sign of the end of a bear market,” Shalett opined.
Nonetheless, the expert said, the consumer is currently holding up quite well, as evidenced by data such as the unemployment rate, wage growth, personal expenses, and retail sales. However, she said, there are already early warning signs that consumer spending is weakening. For example, the personal savings rate, which had been inflated during the Corona era primarily by government checks, “has plummeted from a peak of 33.8% in April 2020 to 2.3% in October 2022—the lowest it’s been since 2005.”
She also said revolving credit card debt is now at a record high and the number of new jobs being advertised is declining.
“Putting all this together, we believe labor-market and consumer-spending data bear watching, as they will help determine what is next for the U.S. economy,” Shalett says.
Looking at the stock market, she says markets have not yet priced a slowdown in growth into current equity valuations and earnings estimates.
Since a “policy-driven bear market” usually only ends when earnings estimates bottom out and the Fed actually starts cutting interest rates, “this means we are likely to be waiting awhile before this bear market in equities is truly over,” she summed up.
