On February 15, during an appearance on Bloomberg TV, Lisa Shalett, the Chief Investment Officer (CIO) at Morgan Stanley Wealth Management, provided a comprehensive analysis of the current state of the U.S. economy and its implications for the stock market.

Economic Conditions: A Closer Look

Shalett began by addressing the overarching concerns surrounding economic conditions, emphasizing the importance of focusing on inflation and growth outlooks. These factors, she noted, are crucial in shaping the labor market and, consequently, the Federal Reserve’s actions throughout the year. Despite disappointing retail sales, Shalett pointed out that the U.S. economy has experienced more positive surprises in growth than negative ones, suggesting a better-than-expected performance in the first quarter.

Corporate Fundamentals and Earnings Season

The discussion then shifted to corporate fundamentals, where Shalett observed a mixed earnings season. While some companies have surpassed expectations, others struggle to expand profit margins, a challenge that was not fully anticipated in their initial guidance. This has led to a scenario where negative earnings revision breadth prevails, indicating a general trend of companies revising their outlooks downwards. This trend, according to Shalett, reflects overly optimistic expectations for 2024 and 2025, with consensus forecasts predicting 11 to 12% year-on-year growth following a year of modest growth.

The “Buy the Dip” Narrative and Market Liquidity

One of the most pressing questions in the current market environment is what could potentially disrupt the persistent “buy the dip” narrative. Shalett argues that as long as excess liquidity exists within the system, investors will continue to find opportunities across all asset classes. However, she forecasts a tightening of liquidity in the latter part of the year, influenced by factors such as increased treasury issuance by Janet Yellen and the ongoing impact of quantitative tightening. This tightening could challenge the prevailing market sentiment and influence asset valuations.

Small Caps and Market Sustainability

Finally, Shalett touched upon the prospects for small-cap stocks, which are particularly sensitive to interest rates and financing costs. For small caps to sustain their performance, there must be a firm belief in a soft landing for the economy, transitioning into a reacceleration of growth. This belief would need to be underpinned by a multi-quarter, sustainable rebound in growth, convincing investors of the viability of small caps in a changing economic landscape.

Featured Image via Pixabay