Goldilocks is dead, warns Morgan Stanley Wealth Management. Risk of economic ‘hard landing’ rising even if ‘pain can be delayed’

Throughout January, the stock market rallied as investors began counting on a “soft landing” for the economy, predicting that the Federal Reserve would be able to tame inflation without triggering a recession. But Lisa Shalette, chief investment officer at Morgan Stanley Wealth Management, warned on Tuesday that “looking through the fog” at a new bull market is a bad idea.

After the US economy added more than half a million jobs last month, sending the unemployment rate to a 53-year low of 3.4% and retail sales jumping 3%, beating economists’ expectations, Shalette fears the Fed will have to keep interest rates. “higher longer” to cool the economy and quell inflation.

“With rising consumption and inflation, the risks of a boom/bust-like hard landing are rising, even if the pain can be delayed for a quarter or two,” she warned on Tuesday.

Recent increases in consumer spending and the labor market, as well as higher-than-expected corporate earnings, have led many investors to believe stocks are moving in a “Goldilocks scenario” where the economy is not too hot or too cold and valuations remain strong. . But Chalette said that would only work if inflation continued to fall. According to the CIO, the latest consumer price index (CPI) and producer price index (PPI) data no longer show “rapidly declining inflation.”

While annual CPI inflation eased from June’s 40-year high of 9.1% to 6.4% in January, it still remains well above the Fed’s 2% target. And PPI inflation, which measures changes in wholesale prices for businesses, was also 6% last month, suggesting that price increases may remain.

Schalette warned that the data meant Fed officials “will face more pressure to cut demand” from higher interest rates throughout 2023, noting that consumer inflation expectations have also risen this month. Economists carefully monitor inflation expectations for signs that price increases are ingrained in the consumer psyche, making them hard to fight.

This means that investors betting on a “Fed put” — or a quick return to low interest rates as inflation falls — “may be wrong this time,” Schalette said.

“We warn that recent gains look extremely fragile,” she added. “The credibility of the Fed is at stake, and it is likely to risk jumping over rather than out of the fight against inflation too soon.”

Morgan Stanley’s base case is for the S&P 500 to end the year at 3,900, about 2.5% below current levels, but bank analysts don’t think that will be a straight forward path. The index could fall to 3,000 this year before recovering.

Chalette warned against “buying the dip” in this environment and advised investors to focus on stocks that pay dividends and have strong free cash flows in these turbulent markets.

This story was originally published on Fortune.com.

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