Morgan Stanley: Housing and Financials Will Lag a Recovery

While Congress' fiscal stimulus package will add "significant short-term stimulus to growth," according to Richard Berner and David Greenlaw, writing in Morgan Stanley's Global Economic Forum, the multiplier effects of the package may be small. The following is an excerpt from their report:

The result will be large swings in both income and spending that will obscure their underlying pattern. We assume that consumers will spend 40 cents of each rebate dollar spread across the third and fourth quarters of 2008, adding roughly three percentage points to consumer spending in those quarters. Our presumption that the structure of the rebates skews their impact toward lower-income recipients will give the plan temporary traction...

Although the Fed has eased aggressively and fiscal help is coming, risk management tactics suggest that officials will take out another 50 bp of recession insurance at their meetings in the spring, bringing the Federal funds rate to 2½%. In our view, the uncertain outlook, economic slack, and easing inflation will give the Fed the latitude to keep rates low for much of the year. ...

For their part, investors still face as many hurdles as the Fed, and the tension between current weakness and expectations for improvement may dominate market sentiment. We expect fundamentals in housing and financials will atypically lag a recovery in the rest of the economy. Despite a better economic outlook, earnings still seem likely to decline this year. Credit quality is only beginning to deteriorate outside of mortgages. All reasons to be cautious about risky assets. But our strategists believe that there is a lot of bad news in the price of risky assets, and bear market rallies seem likely. In fixed income, however, another bear lurks, namely the bear steepening trade that is the product of an aggressive policy mix. Longer yields are likely to rise as investors price in recovery and a return of inflation. More Treasury supply could add to the pressure; we expect that with the fiscal stimulus plan, the FY2008 Federal deficit will rise to $400 billion.

Comments

[Rhett]

How can financials lag when every other sector depends upon their recovery?