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.

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.