Morgan Stanley Says Market Rally Is An Illusion Of Bad Fiscal Policy

But heading into the New Year, he expected stocks would tumble to new lows during the first half of 2023.

And after hanging on to his bearish view for months in spite of a powerful rally in equities driven by the artificial intelligence craze and a surprisingly resilient U.S. economy, he’s recently taken the opportunity to reflect on why he got it wrong, while acknowledging the possibility that the rally could continue.

It’s possible, even likely, that the government’s excessive spending could continue, at least until it comes time to raise the debt ceiling again in 2025.

Fitch Ratings last week cited projections for ballooning budget deficits for helping to inspire its decision to strip the U.S. of its AAA credit rating.

“The main takeaway for the equity market this year is that fiscal policy has allowed
the economy to grow faster than forecast, giving rise to the consensus view that the
risk of a recession has faded considerably. Furthermore, with the recent lifting of the debt ceiling until 2025, this aggressive fiscal spending could continue,” Wilson said.

The biggest problem with spending so much during good economic times, however, is that it limits Congress’s ability to act when another recession inevitably arrives.

That could create problems for corporate earnings and, by extension, stocks, down the road, Wilson said.

“If fiscal policy is showing such little constraint in good times, what happens to the deficit when the next recession arrives?”

U.S. stocks were trading higher early Monday after the S&P 500 SPX logged its fourth straight day in the red on Friday, capping off the worst week for stocks since March. The index was up 0.5% in recent trade near 4,500, while the Nasdaq Composite COMP was 0.2% lower at 13,881.

The Dow Jones Industrial Average DJIA, which has surged higher over the past month as traders have favored some of this year’s market laggards, was up 300 points, or 0.9%, at 35,362.