Morgan Stanley’s Pick says a paradigm shift has begun in the markets. What to expect

Global markets are at the beginning of a fundamental shift after a nearly 15-year period defined by low interest rates and cheap corporate debt, according to Morgan Stanley’s co-president Ted Pick.

The transition from the economic conditions that followed the financial crisis in 2008 and what follows will take “1[ads1]2, 18, 24 months” to unfold, according to Pick, who spoke at a financial conference in New York last week.

“It’s an extraordinary moment; we have our first pandemic in 100 years. We have our first invasion of Europe in 75 years. And we have our first inflation around the world in 40 years,” Pick said. “When you look at the combination, the intersection of the pandemic, the war, the inflation, it signals a paradigm shift, the end of 15 years of economic repression and the next era to come.”

Wall Street executives issued stern warnings about the economy last week, led by JPMorgan Chase chief Jamie Dimon, who said a “hurricane is right out there, down the road, on the way.” This sentiment was repeated by Goldman Sachs President John Waldron, who called the overlapping “shocks to the system” unparalleled. Even regional bank governor Bill Demchak said he thought a recession was inevitable.

Instead of just sounding the alarm, Pick – a thirty-year-old Morgan Stanley veteran who heads the firm’s commercial and banking department – provided a historical context as well as his impression of what the tumultuous period ahead will look and feel like.

The markets will be dominated by two forces – concern about inflation, or “fire”, and recession, or “ice”, said Pick, who is considered a frontrunner who will eventually succeed CEO James Gorman.

“We want those periods where it feels very burning, and other periods where it feels icy, and clients have to navigate around it,” Pick said.

For Wall Street banks, some businesses will boom, while others may be idle. For years after the financial crisis, interest rate traders handled artificially calmed markets, leaving them with less to do. Now, as central banks around the world begin to fight inflation, government bond and currency traders will be more active, according to Pick.

The uncertainty of the period has, at least for the moment, reduced the merger activity, as companies navigate the unknown. JPMorgan said last month that investment bank charges in the second quarter have fallen by 45% so far, while trading revenues rose as much as 20%.

“The banking calendar has calmed down a bit because people are trying to figure out whether we should get this paradigm shift clarified sooner or later,” Pick said.

In the short term, if economic growth continues and inflation calms down in the second half of the year, the “Goldilocks” narrative will take hold and strengthen the markets, he said. (For what it’s worth, Dimon, referring to the impact of the Ukraine war on food and fuel prices and the Federal Reserve’s move to shrink the balance sheet, seemed pessimistic that this scenario would play out.)

But push and pull between inflation and recession concerns will not be resolved overnight. Pick referred several times to the era after 2008 as a period of “financial repression” – a theory in which decision-makers keep interest rates low to provide cheap debt financing to countries and companies.

“The 15 years of economic repression do not just go to what happens in three or six months … we want this conversation for the next 12, 18, 24 months,” Pick said.

Low or even negative interest rates have been characteristic of the previous era, as well as measures to inject money into the system, including bond-buying programs collectively known as quantitative easing. The movements have punished savers and encouraged rampant borrowing.

By tapping the risk from the global financial system for years, central banks forced investors to take more risk to achieve returns. Unprofitable companies have been kept afloat by easy access to cheap debt. Thousands of start-ups have flourished in recent years with a money-burning mandate for growth at all costs.

It is over as central banks prioritize the fight against runaway inflation. The effects of their efforts will affect everyone, from credit card lenders to the aspiring billionaires who run Silicon Valley. Venture capital investors have instructed start-ups to preserve cash and aim for actual profitability. Interest rates on many online savings accounts have risen closer to 1%.

But such shifts can be bumpy. Some observers are concerned about Black Swan-type incidents in the pipeline of the financial system, including the explosion of what a hedge fund manager called “the biggest credit bubble in human history.”

Out of the ashes of this transition period, a new business cycle will emerge, Pick said.

“This paradigm shift will at some point bring in a new cycle,” he said. “It’s been so long since we’ve had to consider what a world is like with real interest rates and real capital costs that will separate winning companies from losing companies, winning shares from losing shares.”