Morgan Stanley’s Sheets Joins Wall Street Crowd Turning Cautious

(Bloomberg) -- Add Morgan Stanley to a growing chorus on Wall Street calling for investor caution amid a superheating global economy.

In a mid-year outlook, chief cross-asset strategist Andrew Sheets said investors face a “hotter, shorter” economic cycle for the first time in a decade thanks to outsized fiscal stimulus, monetary easing, ramping vaccinations and the highest consumer savings rates in history. But the potential for higher inflation, tighter policy, margin pressure and increased taxes could weigh on returns, leading the firm to dial back its exposure to risk assets like credit and stocks.

“Strong economic winds also bring complications,” Sheets wrote in the report published Sunday. “Just 14 months from the lows, investors face early-cycle timing, increasingly mid-cycle conditions and late-cycle valuations.”

Morgan Stanley is the latest investment firm to sound the alarm on the impact of a potentially overheating global economy as concerns mount over rising inflation. Strategists at UniCredit SpA suggested risk-off trades will become more likely in a note Friday, while peers at T. Rowe Price said Monday that equities are vulnerable to potential setbacks amid peaking global economic growth.

The global rebound from the pandemic is stretching supply chains to the brink as companies stock up on raw materials to satisfy reviving demand, fueling a debate on whether price pressures will be transitory or longer lasting and more damaging.

The bulk of Morgan Stanley’s risk reduction is in credit, which strategists downgraded to neutral. “The asset class has had an outstanding run, but is both expensive and disadvantaged in a hotter cycle,” Sheets said.

But the firm also cut U.S. equities to neutral, in favor of non-U.S. shares such as cheaper peers from Europe and Japan, and sees modestly higher yields and a narrowly rising dollar.

The S&P 500 Index is up 11% year-to-date, compared to an 8% rise in an MSCI Inc. index of non-U.S. developed market shares.

Taiwan Warning

Elsewhere, UniCredit strategist Christian Stocker cut technology stocks to neutral, as they in particular stand out among growth sectors for their high valuations. Last week’s selloff in Taiwan could be a warning signal for the sector and the broader growth universe, at least in the short term, he said.

“We recommend focusing on less-yield-sensitive parts of the equity market such as value or cyclical sectors as intensified discussion about higher inflation pushes risk-off trades,” Stocker wrote.

Meanwhile, T. Rowe Price is increasing its underweight in stocks relative to bonds and cash, according to Thomas Poullaouec, head of Asia Pacific multi-asset solutions.

“The risk/reward profile looks less compelling for equities after a strong rebound from March 2020 lows,” he wrote in a note. “Equities could be vulnerable to potential setbacks in the recovery, fading policy support, and higher taxes.”

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