Morgan Stanley
  • Thoughts on the Market
  • Nov 24, 2020

U.S. 2021: Momentum Toward Recovery

Andrew Sheets and Ellen Zentner


Andrew Sheets: Welcome to Thoughts on the Market, I'm Andrew Sheets, Chief Cross Asset Strategist for Morgan Stanley.


Ellen Zentner: And I'm Ellen Zentner, Chief U.S. Economist. And on this special edition of the podcast, we'll be talking about our 2021 forecast for the U.S. economy and markets. It's Tuesday, November 24th, at 9:00 a.m. in New York.


Sheets: And it's 2:00 p.m. in London. So, Ellen, let's start off at the top. What are you expecting for the U.S. economy next year? And how do you think that differs from some of the other major forecasts that are out there?


Zentner: So I think what we've been hearing from clients is that our growth forecasts for next year are so high that they look more like others' bull case. But I think what's hard to argue with is the shape of growth that we're expecting. In the near term term, we're going to go through a difficult winter. We think by the time we turn the corner into the new year we'll have seen consecutive declines in consumer spending and all of that related to the restrictions, renewed restrictions around covid. If Matthew Harrison, our biotech analyst, is right, then the acceleration in cases will have stabilized in January. By February and March, you're starting to have a net pickup in activity and you're moving toward getting vaccinated for the broad population in April with a second dose in June. So next year is really about the good side of the economy, which has been driving growth, giving way to the services sector side of the economy, picking up. And so, I think its sort of easy to think about growth being in a better place by the middle of next year.


Sheets: So Ellen, I'd like to dig into that a little bit more. Our base case for growth next year-- about 6% growth for the U.S. economy-- seems to be closer to other people's bull cases. And so, you know, given we're all looking at the same country, we're all looking at the same population, what are the differences in assumption that you think we at Morgan Stanley are making, that other people are making that kind of gets us to that better ultimate growth outcome.


Zentner: So I think, you know, my sense is that there's this idea out there that the economy will continue to be beleaguered until we get past the vaccine, that there's almost this demarcation and growth from before vaccine, post vaccine. But one thing that we're looking at, and maybe this comes from the benefit of being able to work so closely with a biotech analyst on staff, you know, if you think about when we went into lockdown in the U.S. earlier this year, activity started to open back up and people started to engage more in the economy. And we didn't have a vaccine then. We had case accounts that were falling. They had stabilized, and then they started to come down. And so, the turn of the weather as we get past the winter and we're starting to move into spring, I think that expectation, that case counts will have stabilized and start to recede, that's going to be important in terms of what parts of the economy can start operating again and how comfortable people feel going out again. And so, we have a pickup in growth starting much earlier in the year versus consensus, which almost looks like they're waiting for, you know, mid-year vaccine happens, OK, let's grow again.


Sheets: Well, and I think that's a great point, because you mentioned earlier about that timeline that Matthew Harrison, our biotech analyst, is expecting for vaccine dosing. And maybe if you could comment just a little bit more on that. How important do you see some of this news over the last several weeks? It's felt like we've gotten a new vaccine announcement each Monday for the last three weeks. How much that's affecting how you think about the outlook next year?


Zentner: So I think to me these developments are important because households and businesses can see that there's a light at the end of the tunnel, understanding that we have to have more restrictions now, that activity is going to be more restricted now. But, you know, or you're pretty confident, that this will be over at some point, that there will be a vaccine and you can start to return to normal at some point. And I think that's really what our large-scale consumer surveys are also showing as well that our Alpha Wise group puts together at Morgan Stanley. I think it's an incredibly positive development that helps us weather the winter a little bit better.


Sheets: In addition to the vaccine announcements, there have been some other big announcements this week about what the next U.S. administration could look like, particularly an announcement of a familiar face for the next treasury secretary of the US. So, what do you think the potential kind of policy implications are of Janet Yellen as treasury secretary and more broadly, you know, anything that you're reading into some of these early transition announcements that you think could affect the economic outlook?


Zentner: Yeah. So, I'm glad you asked that question, because, of course, as an economist, I'm just tickled pink that we get an economist at Treasury. So, one thing I see right off the bat is a Treasury and a Fed that are working more in concert together in terms of recognizing how policies, both fiscal and monetary, affect the economy, how the dollar affects the economy, how Treasury's debt issuance can affect financial conditions, and how the Fed is intertwined with that. And so, I think you get much more recognition. I don't want to say coordination, but recognition in terms of how each of those entities affects the economy and works together. I also think that Biden's choice of Yellen is uncontroversial. She is going to be an easier confirmation for him in Congress. And I think that also, on the regulatory front, she has taken a softer approach in the past compared with some of the other names that were that were bandied about for possible treasury secretary. So, I think what we're going to see is a wide embrace of markets for Yellen as treasury secretary. And I think Congress will confirm her. And I also think, and this is very important in terms of most recent developments, I think that because she has recognized publicly the importance of these emergency lending programs of the Fed as an important backstop, I think she will continue to recognize the importance that Treasury funds those facilities properly.


Sheets: I'd actually like to stay on the Federal Reserve for the moment. First, you know, we have an important meeting coming up for the Fed on December 16th and would love your thoughts on what we could hear from the Fed. But more broadly, you know, one silver lining of the data weakness that the markets saw this year was that the Fed was very accommodative in the face of that weakness. They've bought an enormous number of securities. They cut rates to the zero bound. And as the economy gets better, there's obviously an open question of how the Fed would continue that policy.


Zentner: So I think you're getting at the heart of what's been so difficult for investors. You know, how do you deal with an economy that's very weak in the near term, but very strong just six months from now? And the Fed is going to have to deal with that as well, shifting from being very cautious today and providing an extraordinary amount of monetary policy accommodation to deciding when you start pulling back that accommodation just 6-8 months from now. So, based on the strength of the economy that we're expecting next year-- rising inflation, falling unemployment, very fast growth for the economy-- we think that by the beginning of 2022 the Fed should be taking its foot off the gas pedal, is the way I would put it. So, growing its balance sheet, but at a slower pace. And what does that mean? It means tapering their asset purchases. But you have to work backwards from that because Chair Powell has an affinity for giving the markets a good heads up when a change in policies coming, which means by the middle of next year, he should already be talking about the possibility that tapering could be coming. Now, to talk about that today sounds very surprising, but we get into an environment where the vaccine is being rolled out and a lot of the economy is open, and a lot of those service activities are coming back, and it won't seem so unusual at that time for him to be talking about those upcoming policy changes.


Sheets: Ellen, the last thing I want to ask you about is the jobs market. You know, we've seen an unprecedented number of job losses over the last several months in the wake of the coronavirus. And the data since then has been somewhat mixed. On the one hand, the unemployment rate's been coming down, it's been coming down very rapidly. On the other hand, you've seen a rise in signs of long-term unemployment, which can be kind of more damaging, not just obviously to the individual but to long term productivity and other economic variables. And so, you know, when you think about the labor market next year, how do you think it will evolve?


Zentner: Yeah, so I'm glad that you talked about some of these structural issues within the labor market. You look at just the unemployment rate falling and yeah, it looks like it's been an incredible path back to employment for folks. But you look under the hood and you can see, you know, reasons why I've made strong arguments for the need for further fiscal support because you've had women's labor force participation rates drop and as you say, long term unemployed. The longer someone is unemployed, the greater the probability of just dropping out of the labor market altogether. So, we've got to ensure that we get all of those folks back to work. Now, part of that is the roll out of the vaccine. But I do believe that we need more fiscal support and we do expect that more covid related spending at least, is coming after the new prospective administration takes over. But just getting services side of the economy opened up will make a big difference. Services jobs dominate the labor market. Services sector side of the economy dominates GDP. And so, you've got to get the vaccine in place, the economy opened up and more of those services can come back.


Zentner: So, Andrew, we've talked about the U.S. economic outlook. And I want to turn to you for a specific look through the strategist lens. You know, in your strategy outlook for 2021, you and our equity strategist call for strong growth and strong returns for equities worldwide. Paint us a picture of what U.S. equity markets could look like next year. And where do you think the opportunities will be?


Sheets: I think one of the biggest debates we're facing from a strategy point of view next year is will this be a so-called kind of normal recovery, a normal post recessionary period for markets, or are we seeing something completely different?  We at the Morgan Stanley side are very much in that more normal camp, and that's having a big influence on how we're viewing markets. That economic outlook you just described, would be following in many ways what often happens after a recession. That after a recession, the economy is still weak, but it gets better, that the unemployment rate is still high, the labor market is still damaged, but it is getting better, and yields are very low, but they generally rise. Central bank policy is often very accommodative because central bank policy is looking back at the recession that just happened and it can be still helpful to the economy even though the economy is recovering. In that way, I think we can follow some of the other market patterns that often happen post-recession. So that tends to mean good equity returns, kind of above average equity returns. And, you know, we're forecasting gains of, you know, a little over 10 percent for the S&P 500, but can also be even better for smaller, more cyclical stocks within the U.S. equity market, because those are the companies that tend to be more economically geared, tend to rise and fall faster depending on the underlying pace of the economic recovery, and given that the economic recovery is strong, we think they could do better than the market overall. The other thing I think is important to keep in mind here is that when it comes to issues like the labor market, you know, how the labor market interacts with the stock market can kind of vary as the recovery goes on. At the beginning of a labor market recovery that can actually be quite good for corporate profitability, because with unemployment still high, there is less pressure on wage costs and other costs to businesses. And so, your margins are generally healthier, whereas later in an economic cycle when unemployment is lower, it's obviously better for those looking for work because they can demand higher wages. More people are working, that's good for the economy overall, but it can create cost pressures for businesses and thus can be actually more difficult for profitability later on in economic expansion. So, in that way, we think it's very consistent to think that the equity market can still have quite good returns, even if unemployment is still high. It's the fact that that high unemployment is coming down is what we think will matter most interesting.


Zentner: Ah, interesting. You know, another call from your forecast is a favorable outlook for U.S. corporate credit, particularly high yield credit. I'm just curious now that you've had some space to go out and talk with clients about our outlooks, have you received any pushback to that view or what's been the general feedback?


Sheets: Yeah, again, here I sense a real divide in investor expectations. I think most investors generally think that corporate credit will, you know, be fine next year, be some form of positive. But I think there's a real disagreement in kind of what leads it, whether it's the higher quality credit that the Federal Reserve has been supporting or whether it's the high yield credit that tends to be more economically cyclical. And again, we tend to be in that more economically cyclical camp. We think it's high yield credit that will outperform. One of the big debates there, though, is this cycle has happened so quickly. You know, this recession was one of the most rapid declines in economic activity ever. The bounce back has been very quick. And because everything's been so fast, you actually haven't had the type of default rates that usually happen during a recession, let alone a recession of this magnitude. And so, people who are more bearish than us will point to that and say, "look, you just haven't cleared out enough of the bad companies, enough of the weaker credits in the market." That process usually happens during a recession. That process can be healthy. It can kind of clear out businesses that are less profitable, less efficient and kind of leave space then for better businesses to grow and survive. And thus, because you haven't had that process happen this time, as this story goes, many people are more cautious.


Sheets: I really don't think that's the right way to think about the market. I think if what we were dealing with was a lot of companies that were very inefficient and only surviving because of, you know, central bank largesse, then OK, then that's a problem that would suggest a weaker lower growth economy going forward. But at the same time, I don't think that's what we've had happen. I think we've had a really unprecedented shock that hit a lot of different companies who couldn't have remotely been expected to prepare their businesses for a global pandemic, and thus it wouldn't do any economic good for a lot of otherwise perfectly fine businesses to go out of business in a pandemic when that might not be strictly necessary. So, you know, put it another way, you know, the fact that there has been a lot of government support, the fact that there has been a lot of central bank support, the fact that that's prevented a lot of defaults, I don't think that's a bad thing in making the economy kind of less robust going forward. I think it's ultimately going to be a good thing in that we've avoided properly unnecessary pain on the lending side, unnecessary pain on the business side. And thus, the credit market is actually going to be fine coming out of this and can behave like it often does coming out of a recession.


Sheets: Thank you. Thanks, Andrew. Great talking with you. And I know you're in London, but I hope you and your family have a terrific Thanksgiving.


Sheets: Yeah, happy Thanksgiving to you, too, Ellen, and all the best to you and your family. And look forward to catching up again soon.


Sheets: And thanks for listening. To all our listeners in the U.S. best wishes for a joyful Thanksgiving from all of us here at Thoughts on the Market. 

Although the U.S. faces a challenging winter, vaccine availability and momentum could propel the economy to expand an impressive 6% in 2021. The outlook for investors.

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