US stock markets have been bearing the brunt of multiple headwinds in recent weeks and volatility may continue in the near future. Amid this Morgan Stanley’s Chief Investment Office Lisa Shalett advises investors to take caution ahead, seeing at least three areas of uncertainty that may continue to weigh on markets. This year, the S&P 500 is down 16.5%, while NASDAQ is down 25%, and Dow Jones has fallen 12%. Lisa Shalett believes that tightening of monetary policy, dimming corporate profit outlook, and geopolitical worries will continue to weigh on Wall Street.
Tightening monetary policy: The first reason to be cautious, as cited by Lisa Shalett is the acceleration in a move towards monetary policy tightening. “Financial conditions have tightened, and current market expectations show that rates are likely to rise by another 2 percentage points by year-end. As Fed Chair Jerome Powell acknowledged last week, a “soft landing” for the economy is not guaranteed,” Shalett said while adding that 11 of the 14 Fed tightening cycles since 1950 have resulted in recession.
The US Federal Reserve on Wednesday hiked the interest rate by a half percentage point pushing the benchmark above 0.75%.
Corporate profit outlook: Although earnings of US-listed companies have been good in the first quarter of the fiscal year, Lisa Shalett argues that those are not the true reflection of the current economic situation and the tightening of monetary policy. The Morgan Stanley Wealth CIO added that earnings expectations need to be recalibrated, as corporate profits face a number of headwinds, including margin pressure from rising costs, normalization of demand from the early days of the pandemic, weaker international demand, and the strongest dollar in decades, which can hurt U.S. exports and the translation of overseas profits by U.S companies.
Geopolitical worries: Trade, supply chains, and commodities are expected to remain disrupted owing to geopolitical worries outside of the US. With no resolution to the Russia-Ukraine conflict in sight, Shalett says this will create uncertainty for central banks, feed volatility in currencies, produce headwinds to covid-19 recoveries, and raise the pressure on emerging market countries already labouring under high costs.
“With uncertainty high, investors should practice discipline, even as “buying the dip” may seem attractive, and demand compensation for risk in the next six months or so,” Lisa Shalett said. She added that investors should remain patient until there is some clarity around inflation, monetary policy, earnings, and international events. “Consider taking profits in passive indices and redeploying toward active managers, and look to Treasuries, which we think are trading closer to fair value.”