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So far in December, US stocks have reached successive highs, even after the broader benchmark S&P 500 and tech-heavy Nasdaq indices both rose by 11% in November, while the Russell 2000 Index of small-capitalization stocks jumped 18%. Lisa Shalett, Chief Investment Officer, Wealth Management at Morgan Stanley, expects the US economy to surge early next year with policy-fueled expansion pushing up long-term interest rates while powering a rotation in stock-market leadership based on four key factors.

Key quotes

“Never before have we seen such high unemployment (currently 6.7%) accompanied by rising personal incomes, a savings rate that has doubled in one year, lower credit-card balances and higher net worth. The power of increased spending capacity matched with pent-up demand for deferred vacations, restaurant meals, sporting events and entertainment could fuel economic growth, as the pandemic starts to recede sometime next year.”

“Rising US home values are making many Americans feel wealthier. New home construction is rising, with housing starts in October up nearly 5% from September. Strength in the housing market has a multiplier effect, with rising sales leading to more spending on home improvements, new appliances and other household goods.”

“Federal Reserve stimulus has dramatically expanded the money supply. Price declines in the service sector, due to the COVID-19 recession, have so far helped to mask that pressure on inflation. But if services inflation returns to its three-year pre-pandemic trend of roughly 3%, the Consumer Price Index, a key gauge of inflation, may quickly overshoot the Fed’s 2% target next year.”

“The Fed remains committed to keeping interest rates low long-term. At the same time, Congress seems much more inclined lately to pass a new fiscal stimulus bill before year-end. President-elect Joe Biden’s selection of former Fed Chair Janet Yellen as the next Treasury Secretary suggests a more coordinated policy response between fiscal and monetary authorities, which could result in more government spending and debt monetization. That would likely add to dollar weakness and higher inflation.” 

“Caveats remain. Still, weak US labor markets could mute consumer spending and inflation. Problems with the vaccine rollout could emerge. The Fed could manage to keep interest rates low. However, we believe those odds are low.”