Morgan Stanley
  • Thoughts on the Market
  • Oct 15, 2020

Playing the Reopening and Recovery Into 2021

Ellen Zentner and Adam Virgadamo


On this Special Episode, Chief U.S. Economist Ellen Zentner talks with U.S. Equity Strategist Adam Virgadamo about the path to recovery and mispriced “reopening stocks.”

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Current Episode Transcript

Ellen Zentner: Welcome to Thoughts on the market. I'm Ellen Zentner, chief U.S. economist for Morgan Stanley.

Adam Virgadamo: And I'm Adam Virgadamo, U.S. equity strategist. On this special edition of the podcast, we're going to be talking about the ongoing economic recovery in the U.S. and how investors could look at potential reopening opportunities in 2021. It's Thursday, October 15th, at 11:00 a.m. in New York.

Virgadamo: So, Ellen, with each passing day, it's looking a little bit less likely that Congress will pass a stimulus bill before the election. What do the fourth quarter and 2021 look like to you without a near-term stimulus package? And what are you hearing about a post-election or maybe post-inauguration package and how that could look.

Zentner: You know, as we move further into the fourth quarter here, growth is slowing. And some of that is that we didn't get a further fiscal stimulus package. And so just mechanically, we're not going to have as strong a quarter as we did when we were coming out of lockdown. In terms of the various scenarios post-election laid out by Mike Zezas, our U.S. public policy strategist, of course the split Congress scenario, regardless of who's in the White House, holds the least prospects for further stimulus spending. You probably need a bobble in the economy, a significant bobble in markets, in order to provide that impulse that Congress would need to act. But certainly under a Democratic sweep, under a Republican sweep, you do get further fiscal stimulus, particularly under a Democratic sweep. I would be encouraged if we were to see serious progress on infrastructure spending package. These are the kinds of policies that would carry much higher multipliers for the economy in 2021.

Virgadamo: Well, near-term, I think the focus is probably gonna be on the consumer because you can't think about the U.S. economy without really thinking about that consumer. We know that the benefits from CARES, the original package, expired at the end of July, and yet consumer confidence was actually remarkably strong in August and September given that loss of income. If a package isn't passed near term, what are your expectations for the U.S. consumer over the next few months?

Zentner: Not only did confidence rise, as you noted, but spending continued to rise as well. And so we've taken a really close look at what the cushion of savings was like that was built up during the first CARES Act that went into place during lockdown. And we actually built up savings across all income groups. And those lower income groups we think are dis-saving now. And that's how they've continued to be able to spend even in the absence of an extension of those benefits. And so growth is going to be slower in the fourth quarter. But I guess the difference to me is that that savings cushion means we're not talking about "Economic Armageddon" because those extensions were not passed.

Virgadamo: So I guess there's two ways to pad that savings cushion. One is going to be additional fiscal stimulus going to the consumer. The other is that we bring jobs back to the economy. So just this morning, actually, we had jobless claims data released. I think the number came in just below 900,000. Meaning new unemployment claims, you know, were maybe moving up directionally. Where do you think the unemployment numbers go? Both with and without the fiscal package.

Zentner: How we move through a second wave of infections and how much economic activity continues to open up as we move toward a vaccine will be key here, because at the base of it, that's your backdrop. And so just the economy continuing to open up, will continue to bring jobs back. And so even without further fiscal stimulus, we're looking at an unemployment rate that's around just under 8% now, that we think can get to 6%, six and change, by the end of next year. So continued improvement. But you provide further rounds of fiscal stimulus, you put in, you know, big policies with big multiplier effects for jobs as well next year, a year when we will also be getting a vaccine, and it could be much more powerful for the labor market. And so you could easily see the unemployment rate getting down to 5%, maybe even lower than 5 %, in that scenario by the end of next year.

Virgadamo: So, let's talk about that vaccine a little bit. Clearly, there's a lot of investor focus, a lot of consumer focus on that. In your view, though, what's the lag time for the economy and the employment rate to start to move once the vaccine is identified and we start distributing it? How fast does the actual hard data start to pivot?

Zentner: Yeah, so I'm glad you talked about the hard data. Because of course, the soft data can move very quickly. Right? Consumer confidence because of positive news on vaccine development or broad dissemination of a vaccine that's beginning. I think, in this case, unlike a typical cyclical recovery, where there is a longer lag time between stronger economic growth and the unemployment rate reflecting that stronger growth, I think the lag time can be much shorter here. Because state governments and local governments are likely to allow greater capacity, especially in high density services in the economy, to open up quickly as we broadly disseminate a vaccine, I think that you can actually see that lag time shorten.

Zentner: That's a good pivot to some of the work you've been doing recently on, you know, what's mispriced in terms of reopening and recovery stocks. You know, can you walk us through some of the finer points there?

Virgadamo: Sure. So we did publish a note on this just last week, actually, and the impetus for it was that many stocks have already recovered. Right? I mean, they are back to close to or above prior highs. So when you go forward to the beginning of 2021, I think many investors are looking for ways to play a recovering economy, a reopening economy, if you will. But again, many stocks are priced at the highs. So we went through an exercise to say, let's think about which stocks maybe aren't priced for that. And we did some simple math. And then we leveraged our research department, to overlay their subjective judgment. And what we ended up with was a list of about 44 stocks that we don't really think are appropriately priced for that state of the world. Again, a reopening and a recovery. And what's nice about the list, Ellen, is that it's got diversity across end markets. It's got diversity across themes. So obviously, airlines would be a play on a reopening economy. But so are food distributors for restaurants. Right? So are banks as the economy recovers overall. And it's a list of stocks that we feel, both quantitatively and with subjective input from our analysts, can offer pretty material upside into next year if this message plays out on the economy that you do see a recovery and a reopening with vaccine data and additional fiscal stimulus.

Zentner: Yeah, you know, it's interesting that you mentioned airlines in that because I often get, you know, asked questions of-- and this goes back to the life after COVID work that your team and my team did together-- you know, are people ever going to fly again? And I always go back to, you know, as a practicing economist, post- financial crisis, there were many "never will we evers" that came out of that. But it turns out we will do all of those activities again, you know, as these crises move further and further into the rearview mirror. So I've always been of the strong mind that we will travel again, we will go to the movies again. We just need to get this thing further into the rearview mirror. But let me ask you about tech stocks here. You know, can they surge higher next year on a recovery? Is this something where, you know, we've seen the heyday for tech stocks and when we get out of this, you know, a lot of that spending has already been done. I mean, how are you viewing tech in this right now?

Virgadamo: Well, I'd say at the outset two things. One is that tech stocks have performed very well because in many cases, the business models are remarkable. They are built for a transition into a more digital data driven age. And particularly with some of the ways the world changed, post-COVID, that was almost a recession ready made to play to the strengths of these companies that we're delivering in that way. The other benefit that these tech stocks tended to have relative to other stocks was that as interest rates have come down, they tend to be a little bit more interest rate sensitive in valuation, given that the cash flows they're going to distribute are further out in time. They're longer duration assets, if you will. So you really had sort of dual tailwinds working in their favor. From a market leadership perspective, what we're a little bit more keyed in on is perhaps the second derivative changing on growth. So we're actually looking to the more GDP sensitive and cyclical parts of the market that perhaps are not priced for a recovery for market leadership. I think the other factor to consider is, again, the rates environment. We would expect that as the recovery takes hold, rates will begin to move higher and that would be a bit more of a relative valuation headwind to some of these technology stocks. So it's not to say that these stocks don't perform in absolute terms. Again, the economy is growing. They're terrific business models. On a relative basis, though, the rate of change on growth and interest rates we think may favor some other pockets of the market.

Zentner: Adam, I always enjoy chatting with you.

Virgadamo: Great speaking with you too, Ellen.

Zentner: And thanks for listening. If you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple podcast app. It helps more people find the show.