Three tenets of conventional investing that might reverse as volatility becomes 'the new normal', according to Morgan Stanley

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Morgan Stanley
NEW YORK – JUNE 09: Morgan Stanley headquarters are seen June 9, 2009 in New York City. Morgan Stanley is one of ten lenders that won U.S. Treasury approval to pay back $68 billion in funds from the Troubled Asset Relief Program (TARP). (Photo by Mario Tama/Getty Images)

  • Volatility is becoming the norm within the US equity market, meaning certain tenets of conventional investing might reverse, according to Morgan Stanley’s Lisa Shallet.
  • Political gridlock, usually seen as a positive, preventing increased taxation or regulation, might become a negative as political cooperation is necessary to issue pandemic relief, which could create jobs and boost incomes.
  • Higher taxation could unavoidable as Governments need to finance their debt which could otherwise “drag” on the economy.
  • Rising inflation might be beneficial, stimulating consumer spending and “supporting growth”.
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US market volatility has somewhat become the norm over the past few years and this trend isn’t going away any time soon. The VIX index, an instrument used to measure volatility in the US equities market, has traded above the 30% mark in more weeks this year than it had done in the prior 10 years.

These swings in volatility, or “a rise in the volatility of volatility” signal that structural change is afoot,  according to Lisa Shallet, chief investment officer for wealth management at Morgan Stanley.

“We see two powerful undercurrents: a new and different business cycle and a major shift in fiscal and monetary policy, resulting from the inability of Federal Reserve policies over the past decade to generate a normal level of growth,” she said.

With investors starting to acknowledge that certain central policies – like government spending, regulation, inflation and deficits – might be necessary for economic growth, she argues these three “policy-related tenets of conventional investing wisdom” could reverse.

Political Gridlock

Conventionally, this is seen as a positive for markets, as different branches of government are held by rival political parties as “it limits potential for new regulation and tax increases,” she said.

“However, we believe investors are slowly embracing the need for a greater level of cooperation and compromise in Washington,” she said adding that this would lead to more government spending, “including pandemic relief and infrastructure spending, which stands to create jobs and boost incomes.”

Higher taxes

For many investors, tax increases are regarded as an “impediment to corporate earning and economic growth,” she said.

But, with the backdrop of the COVID-19 recession, with its record deficits and debt alongside record low interest rates, this could “drag the economy and weigh on the dollar,” she said. Therefore, new revenues will be needed to finance the debt, meaning “reforming the tax code, including raising corporate taxes, may be unavoidable,” she added.

Rising Inflation

Inflation has “triggered bear markets in the past”, leaving a sour taste in the mouth for many investors, but the Fed’s new “average inflation targeting” framework could allow inflation to float above the 2% target for years, making up for the lower rate over the previous few years when it has got nowhere near this level, she said.

A higher level of inflation could stimulate current consumption versus savings, supporting growth and lessening the burden of high debt, she said, “since borrowers essentially would be repaying loans with dollars that are worth less.”