3 Pockets of Economic Stress to Watch

Mar 26, 2024

Growing consumer debt, falling business sentiment and rising loan delinquencies in commercial real estate could sap the economy’s momentum. How can investors prepare?

Lisa Shalett

Key Takeaways

  • The U.S. economy has shown resilience to the Fed’s rapid rate hikes, but there are signs of potential stress.
  • Consumers could experience higher interest costs on their growing non-mortgage debt, particularly credit cards.
  • The prospect of higher-for-longer rates is also weighing on business sentiment and already-vulnerable sectors like commercial real estate.
  • Investors should consider reducing exposure to consumer discretionary stocks, favoring industrial cyclicals, capital-market-leveraged financials and defensives. 

Tempered expectations of the Federal Reserve’s plans to cut interest rates don’t seem to be slowing down equities, where economic strength in the U.S. has helped push stocks to all-time highs.


While many investors appear to be shrugging off the possibility of higher-for-longer rates—and the potential drag on growth—Morgan Stanley’s Global Investment Committee thinks the insensitivity to higher rates isn’t sustainable or realistic for every corner of the economy. Here are the areas where we see accumulating signs of potential stress: 

  1. 1

    While spending on services and, more recently, housing remains robust, goods consumption has begun to weaken, as revealed by disappointing data on core retail sales (which excludes sales of automobiles, gasoline, building materials and food services). In particular, consumers, especially those in lower-income households, may be starting to feel the bite of higher interest expenses on their growing pile of debt aside from their mortgages. Aggregate credit card balances now total $1.1 trillion, up more than 45% from pre-COVID levels. And with a median credit card interest rate above 20%, the median household is left paying as much in credit card interest payments as their mortgage interest payments. Higher-for-longer rates certainly won’t help.

  2. 2
    Small businesses:

    The prospect of higher-for-longer rates doesn’t seem to be helping sentiment among small-business owners either. The sentiment index of the latest National Federation of Independent Business survey fell to 89.4 in February, its 26th consecutive month below its 50-year average of 98. Business owners reported a diminished appetite for hiring and capital investments, while concerns remain around profits and the difficulty of obtaining credit. Survey respondents also indicated low intentions for raising employee wages and a greater likelihood of price increases to hold margins.

  3. 3
    Commercial real estate and regional banks:

    Persistent high interest rates are also likely bad news for already-vulnerable sectors that have been operating on short-term financing, such as commercial real estate. Owners in this sector have been getting by thanks to the liquidity provided by shadow banking and private lenders. But over the past year, office-space values have fallen by more than 35%, and Morgan Stanley Research has suggested additional downside of as much as 10%. It’s also notable that regional banks own 60% to 80% of related loans that are coming due in two to three years. With delinquency rates rising, commercial mortgage-backed securities may be among the first areas where this stress becomes visible. 

What Does It Mean for Investor Portfolios?

Stock-market prices and valuations continue to look disconnected from the fundamentals of rates, inflation, earnings-forecast revisions and any gaps between actual and projected economic data. This backdrop suggests the possibility of “stagflation”—slower growth with sticky inflation. We remain focused on finding investments with justifiable valuations and diversification in portfolio construction.


Investors should pay attention to data around consumer confidence, labor markets and credit card delinquencies. And consider reducing exposure to consumer discretionary-oriented stocks in favor of a mix of:


  • industrial cyclicals, in such sectors as materials, energy and infrastructure
  • capital-market-leveraged financials
  • defensives like utilities and real estate investments trusts (REITs)


We recommend investors shift more of their portfolio toward intermediate-duration fixed income, as well as credit and equity-leveraged hedge funds.


This article is based on Lisa Shalett’s Global Investment Committee Weekly report from March 25, 2024, “The Haves and Have-Nots.” Ask your Morgan Stanley Financial Advisor for a copy. Listen to the audiocast based on this report.

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