The

Great Rotation

Out of Stocks

Morgan Stanley: "Only One Thing Will Allow Central Banks To Keep The Party Going"

Last week, we presented readers with the latest note from SocGen strategist. Albert Edwards, who explained why after so many years of false rate hike starts, the market not only responded to last week's hike in a dovish manner - interpreting last Wednesday's 0.25% hike as a 0.25% rate cut- but as Goldman Sachs showed previously, the dovish reaction was one of the strongest ones since the financial crisis, in other words: "the market no longer believes the Fed." 

If the market took the FOMC at their word and discounted a 3% Fed Funds rate at the end of 2019 and beyond, then we'd probably have a 3% nominal 10-year Treasury yield by now."

That said, a 3% Fed Funds rate would also lead to steep selloff in risk assets as the dividend yield on the S&P, currently at about 2%, would be about 1% below the risk free rate, leading to a wholesale "great rotation" out of stocks. 

What is Morgan Stanley's conclusion? Simple: for the party to continue, not only must the Fed revert back to its quasi-dovish mode, but for that to happen the recent economic "rebound" has to end (the sooner the better), extinguishing any reflationary impulse, removing the impetus for Yellen to hike aggressively further, and allowing the Fed to remain on hold for an indefinite period of time.  In short: "In our view, for the cycle to last another several years, we want to see more of the same – a continued environment of ‘ok’ growth and low inflation, which allows central banks to keep the party going." 

Hopefully Trump, whose policies threaten to upstage this delicate balance benefitting the 1%, has read the memo.

 DYI