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Is the U.S. Economy Poised for a Comeback?

Jul 18, 2023

Though corporate profits may worsen near term, a strong labor market, robust housing demand and resurgent business spending could help reignite U.S. economic growth next year. How should you invest?

Author
Lisa Shalett
Lisa Shalett

Key Takeaways

  • June’s cooler-than-expected inflation reading is bolstering investors’ confidence in a rebound for the U.S. economy and corporate profits in 2024.
  • Strength in the U.S. labor market, housing sector and corporate investment could help spur renewed economic growth.
  • In this environment, investors should look for opportunities in commodities and industrials, energy, housing, financials and healthcare stocks.

The latest consumer price index data showed U.S. inflation has eased to 3%, the slowest pace in more than two years. The cooler-than-expected reading seems to be allaying investors’ concerns about the Federal Reserve’s rate hikes and bolstering their confidence in a re-acceleration of economic growth and a strong rebound in corporate profits in 2024.

 

Indeed, market-based forecasts suggest S&P 500 company earnings will advance at least 10% next year to a new high, which would be 48% greater than their 2019 levels. Stock prices continue to move higher, now reflecting a forward price-earnings ratio of nearly 20. To many investors, these dynamics no longer illustrate an economy that might muddle through a “soft landing,”—an economic slowdown that avoids recession—but one that may be set for an expansion.

 

Morgan Stanley’s Global Investment Committee has long been skeptical of such a sanguine outlook. We have maintained that company profitability is likely to get worse before it gets better, given factors such as decelerating real economic activity, weak new orders, diminishing pricing power and lagging impacts of higher interest rates.

 

However, we do see bright spots in the economy that may support economic resilience:

  1. 1
    A strong labor market:

    Unemployment, currently at 3.6%, is near 50-year lows, and for every unemployed person, there are about 1.6 job openings, compared with a 15-year average through May 2023 of fewer than 0.5. With price pressures easing, personal incomes may see some gains, when adjusted for inflation, for the first time in this business cycle. Not all of those income gains may go to spending, as individuals may decide to save more or pay off debt, but ultimately a stable jobs market should prevent a collapse in consumption, which accounts for about two-thirds of U.S. GDP.

  2. 2
    A tight housing market:

    Despite higher mortgage rates and sluggish activity in existing home sales, household formation is outpacing home availability, putting a floor under overall home prices and activity. These supply-demand dynamics may help prevent material weakening in housing, which is a major, rate-sensitive part of the economy.

  3. 3
    Resurgent capital spending:

    Positive drivers of capital investment today include strong corporate balance sheets, productivity-boosting enterprise technologies and fiscal spending programs focused on decarbonization and realignment of global supply chains—all with the potential to spur renewed economic growth.

With these factors at play, the economy may indeed re-accelerate. If it does, the stock market is likely to feature a new set of winners, with today’s high-flying consumer-tech and media names giving way to leaders from other equity sectors, such as industrials, energy, housing, financials and healthcare, as well as commodities.

 

In the spirit of “skating to where the puck is going, not where it has already been,” investors should consider trimming passive index-level exposures to U.S. stocks and rebalancing toward the above-mentioned sectors that are better aligned with a resilient economy.

 

This article is based on Lisa Shalett’s Global Investment Committee Weekly report from July 17, 2023, “A New Narrative: Reflation.” Ask your Morgan Stanley Financial Advisor for a copy. Listen to the audiocast based on this report.

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Index Definitions

S&P 500 Index: The Standard & Poor's (S&P) 500 Index tracks the performance of 500 widely held, large-capitalization US stocks.

Risk Considerations

Equity securities may fluctuate in response to news on companies, industries, market conditions and general economic environment.

The value of fixed income securities will fluctuate and, upon a sale, may be worth more or less than their original cost or maturity value. Bonds are subject to interest rate risk, call risk, reinvestment risk, liquidity risk, and credit risk of the issuer.

High yield bonds (bonds rated below investment grade) may have speculative characteristics and present significant risks beyond those of other securities, including greater credit risk, price volatility, and limited liquidity in the secondary market. High yield bonds should comprise only a limited portion of a balanced portfolio.

Companies paying dividends can reduce or cut payouts at any time.

Asset allocation and diversification do not assure a profit or protect against loss in declining financial markets.

Investing in small- to medium-sized companies entails special risks, such as limited product lines, markets and financial resources, and greater volatility than securities of larger, more established companies.

Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies. Technology stocks may be especially volatile. Risks applicable to companies in the energy and natural resources sectors include commodity pricing risk, supply and demand risk, depletion risk and exploration risk. Health care sector stocks are subject to government regulation, as well as government approval of products and services, which can significantly impact price and availability, and which can also be significantly affected by rapid obsolescence and patent expirations.

The indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment.

The indices selected by Morgan Stanley Wealth Management to measure performance are representative of broad asset classes.  Morgan Stanley Wealth Management retains the right to change representative indices at any time.

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Morgan Stanley Wealth Management is the trade name of Morgan Stanley Smith Barney LLC, a registered broker-dealer in the United States. This material has been prepared for informational purposes only and is not an offer to buy or sell or a solicitation of any offer to buy or sell any security or other financial instrument or to participate in any trading strategy.  Past performance is not necessarily a guide to future performance.

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