Economy points to consumer divergence: Strategist

As elevated interest rates continue to impact consumers, economic uncertainty persists. Dan Skelly, Morgan Stanley Wealth Management managing director and head of market research and strategy, joins Market Domination to share his outlook.

Skelly observes "mixed data" across recent economic indicators and conflicting consumer signals. However, he notes that "clarity" is emerging: the longer rates remain high, the more pronounced the divergence becomes between rate-sensitive and less rate-sensitive cohorts. This dynamic is creating a notable disparity between high-income and low-income earners.

Given this situation, Skelly explains, "If the top income cohorts account for the majority and the lion's share of spending, if that second track begins to degrade or slow down, can that actually move the overall averages? And our view is most likely not." This perspective reinforces his stance on a potential economic soft landing scenario.

For more expert insight and the latest market action, click here to watch this full episode of Market Domination.

This post was written by Angel Smith

Video transcript

For more on the markets.

Joining us now is Dan S Kelley Morgan Stanley Wealth Management, managing director, head of Market research and strategy team, Dan, it is good to see you um on the fed, Dan, I thought you made an interesting point here.

You say the longer the fed keeps rates restrictive and allows lag effects to impact the economy, the more the haves and have nots may diverge.

What did you mean by that, Dan, walk us through it?

Sure, Josh and thanks for having me uh back on the show today.

So, you know, simply put, we have seen uh certainly a set of mixed data across the economy across the consumer uh environment.

But I think more and more we're getting clarity that like I said, the longer rates stay higher, the more you're gonna see this divergence between certain corporate and consumer cohorts who are more rate in sensitive and those who are less rate sensitive.

Uh and frankly, you know, you can intuitively think about all the different applications of that concept.

But on the consumer front, it's playing out in terms of high income versus low income, homeowners who have fixed mortgages versus those who are uh maybe trying to buy.

And then of course, renters on the course side, look, it's the reality that there's a certain cohort of large companies that have net cash balance sheets.

Uh and they're actually seeing their interest income out uh exceed interest expenses given the rate environment on the short end as well.

And then there are companies frankly more down the cap curve and small cap land who have more leverage, who are frankly seeing the pain from high rates.

Dan, it's Julie here.

So as you look at that have and have nots then scenario, what are the implications then for the economy in the markets?

Because, you know, we've heard a lot of economists come on the show and talk about how the upper echelons of income account for the bulk of consumer spending anyway.

So, you know, talk us through sort of the implications of what you're saying, Julie, it's great to be with you as well and you, you make a really astute point which is, you know, mathematically, if the top income uh cohorts account for the majority in the lion share of spending.

If that second track starts to degrade or slow down, can that actually move the overall averages?

And and our view is likely not.

So Morgan Stanley from a firm perspective is still in the soft landing camp, right?

So we still see albeit two track divergence amid these different groups, we still see the overall picture as fairly positive, but it puts the fed in a really tricky place because frankly just keeping rates higher isn't necessarily changing the behavior of the one track that isn't rate sensitive, right?

And, and in some instances as well, if you're cash rich and you're now seeing 5% yield on cash, you're then taking that income perhaps and going out and spending more, which, you know, you can make the case.

It's a bit counterintuitive, but you can make the case that rate staying at these levels perhaps is supporting high inflation in certain services.

So Dan, I if that's what your views on the fed the economy where we're at and where we're headed, what are the investment implications, Dan for, for equity investors?

Listening right now?

Absolutely, Josh.

So I'll say two things first in the near term.

It's just more of the same, right?

It's not trying to get too creative uh by fighting the momentum in some of the larger cap uh cash rich type business models who are not only seeing the benefit from uh you know, essentially being insulated from high rates, but also benefiting from these idiosyncratic spending trends, whether you, whether it be in the tech sector or semis or in some of the internet and software uh areas, whether it be in the industrial sectors where you're seeing massive fiscal spending on certain priorities, um You essentially don't want to fight uh some of the earnings power some of the momentum in these areas.

Having said that though Josh, the second thing I would say is um you want to start thinking about a world like 6 to 12 months from now where frankly some rotation may start to finally occur.

And what would we be thinking about in terms of those themes?

Well, look, our base case again is a soft landing scenario where the fed is cutting later this year.

Uh Ellen Zetor, our economist who I think has had this call as close to spot on as anyone is still looking at potential for three cuts this year.

And so at a certain point, Josh, the puck is going to start going to more value oriented parts of the market, more frankly, cyclical parts of the market.

And that is something we are thinking about coming into the end of this year.

I was gonna ask about timing there, Dan, because that is a call that, you know, has been that's out there and that hasn't yet come to fruition is the signal for that gonna be when the fed starts cutting.

And by the way, as we're talking about cutting, I think the last time we talked to you, you were still looking for three cuts this year and I wonder if you're still there, stick, sticking with three.

So I'll answer the second part first, which is, you know, we had thought the path of uh disinflation would be lumpy in the first half of this year and that played out to A t the first quarter had some seasonal factors.

Uh It had some issues that uh certainly we thought were more one off and look as per the last two months of data.

It does look like that glide path towards the FEDS goals are, are more in scope, right?

And so we do think the path of resuming uh disinflation uh is getting there.

And look importantly, as you know, the Fed has explicitly said we're not going to wait to kind of stick the 2% landing exactly before we start cutting.

And and frankly, I think that's pretty wise because as you know, there are structural issues that have frankly built up since the post 08 environment in terms of housing supply, in terms of labor shortages, that frankly, I don't think we're going to really solve with any type of monetary policy policy in above itself.

And so I think if the Fed sticks to that guidance in terms of not waiting to the 2% landing, um I think you can start to think about positioning in some of those value parts of the market coming into this fall.

Now, as you said, a lot of people have tried to make that call so far.

It's been difficult because frankly, a lot of the fundamental earnings revision like I talked about and momentum has been in uh some of the other growth sectors All right, Dan, thanks a lot.

Good to see you, Dan Skelly.

Great to talk with you again.