Morgan Stanley
  • Wealth Management
  • Feb 1, 2021

Keep Your Eyes on the Economic Recovery

Investor anxieties about the pandemic, partisanship and policy have fueled market swings, but retreating to 2020’s big-tech winners may not be the solution.

January was a tumultuous month for U.S. markets. While technically speaking, the broader market S&P 500 index ended the month slightly lower, the real significance lies in the market’s retreat from cyclical sectors that define an economic recovery—such as financials, small caps, energy and industrials, down around 8%—back to big tech winners, many associated with the “work from home” theme, up nearly 3% for the year.

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This reversion will likely prove temporary. Longer term, we believe that the economic recovery and reflation scenario will stay on track, despite investor concerns over recent bouts of stock market volatility.

Here’s a look at three areas of doubt for investors and why we remain optimistic for the year: 

  • Anxiety over the slower-than-expected pace of vaccinations may be overblown. A successful vaccine rollout plays a critical role in fully reopening the U.S. economy by the second half of 2021. Nearly 24 million shots have been given in the U.S. and the rollout has accelerated. Plus, nationwide, daily new infections, hospitalizations and fatalities have all started to decline steadily, giving hope that the U.S. may be turning a meaningful corner, despite the appearance of new coronavirus variants.
  • The Federal Reserve could reverse its dovish policy stance, but that seems unlikely. Could inflationary pressures force the Fed to reign in its robust monetary stimulus? We view last week’s Fed updates as unequivocally dovish, with its commitment to keep injecting liquidity via its $120-billion-a-month bond-buying program unchanged. Tellingly, Fed Chair Jerome Powell said that “the bar was extremely high” to convince the Fed that it needs to worry about inflation expectations. Indeed, Morgan Stanley & Co. Chief U.S. Economist Ellen Zentner doesn’t believe that the Fed will even discuss scaling back on stimulus before the end of 2021, at the earliest.
  • Congress could fail to pass more stimulus, but we think it will succeed. The latest partisan infighting may slow additional federal funds to battle the pandemic and boost the economy, adding to investors’ more defensive mood. Still, we believe that the probability for at least another $1 trillion in COVID-19-related stimulus between March and May remains high. Investors’ patience will likely be rewarded.

To be sure, vaccine distribution logistics and new variants of COVID-19 pose risks to the recovery. However, we believe that retreating to the overvalued, tech-heavy side in the S&P 500 could prove more costly.

As long as the pace of the vaccine rollout accelerates through March, the second-half economic rebound will likely stay on track. Indeed, the uptick in volatility could present investors with opportunities to take up selective positions in cyclical businesses with strong valuation support that stand to benefit from the recovery. These include sectors such as financials, industrials, consumer discretionary and energy.

This article is based on Lisa Shalett’s Global Investment Committee Weekly report from Feb 1, 2021, “Game Time.” Ask your Financial Advisor for a copy or find an advisor. Listen to the audiocast based on this report.

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