The S&P 500 sets up a “trap”, warns Morgan Stanley, shares 3 transactions to be carried out

  • It’s no longer safe to just “buy the drop,” says Mike Wilson, CIO of Morgan Stanley.
  • Slower growth and rising interest rates are a dangerous combination for markets.
  • Financials, health care and consumer staples stocks should hold up better than their peers.

Stocks were whipped in September as a debate rages between bulls and bears over whether the latest market drop is worth buying.

Eighteen months of steadily rising stocks have had a numbing effect on many investors, who now appear to jump reflexively and add to their portfolio positions when stocks slide. This “buy just to buy” sentiment has shifted in recent weeks, and many market participants now appear to be eager to sell in the face of any perceived threat – legitimate or not.

A concern two weeks ago was seasonal weakness, as stocks have historically fallen in September. Last week, some investors panicked as Evergrande, one of China’s biggest real estate developers, looked on the verge of collapse. This week, the rapid rise in bond yields reduces the risk premium of stocks and makes them relatively less attractive.

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A chorus of market experts – from the BlackRock Investment Institute and JP Morgan to others Insider spoke to – called the recent weakness in equities a great buying opportunity. Mike Wilson, chief U.S. equities strategist and CIO of Morgan Stanley, strongly disagrees.

Slowing growth and rising interest rates are about to be a two-part punch for the S&P 500, Wilson wrote in a September 27 note, adding that the 500-component index seems to have broken an uptrend last week. This could mean that stocks are in serious trouble.

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“With the blurry technical picture, now is the time to trust fundamental and cyclical analyzes that suggest lower stock prices to come,” Wilson wrote. “As growth slows and financial conditions tighten, valuations are expected to drop from their high levels. “

Wilson acknowledged that recent stock market swings “can be interpreted upward or downward,” suggesting that there is significant confirmation bias among investors. In other words, both bulls and bears can be criticized for seeing what they want to see.

“Don’t underestimate the power of price in determining how investors interpret facts,” Wilson wrote. “Just as negative price action can cause people to sell lower, positive price action can force people to buy.… We think this may be a time when the markets are playing tricks. to investors and even set a trap. “

Morgan Stanley’s bearish beliefs stem from a hunch that third quarter earnings will come back to earth after a record season in the second quarter. In the last quarter, profits beat expectations by 14% to 22%, which Wilson says is well above the median of 5% since 2005. Analysts have already lowered estimates for the coming season by 0.77% over the past month, the note says.

“We don’t think businesses will continue to beat at such an unprecedented pace and believe that the third quarter could see a significant shift in the most recent trend as supply chain issues and labor shortages ‘Work represent a risk to sales and margins, “Wilson wrote.

Analysts may be a little sour on Q3 estimates, but they maintain margin estimates for 2022 that are “historically high,” Wilson wrote, adding that his team expects profit margins to rise. contract – not to increase. Morgan Stanley’s contrarian opinion is based on the idea that wage growth will be higher relative to GDP growth, which the note says is often linked to tighter margins.

Companies have shown a strange ability to pass price increases on to consumers to isolate their bottom line, but these higher consumer prices can erode demand from households who have already “over-consumed” in many areas in recent months. Wilson wrote.

“Corporate transcription mentions of ‘cost pressures’ and related terms are historically high,” Wilson wrote. “When this has happened in the past, the margins have consolidated.

Investors can prepare for a broader market downturn and “unfavorable” risk-return outlook by holding finances stocks and those of defensive sectors such as health care and basic consumer productsWilson wrote.

Wilson has always advocated for finance as interest rates rise, as higher lending rates are expected to boost bank profitability. The

Federal Reserve
, which indicated last week that it would soon cut its ultra-relaxed monetary policy, could ease the move faster than expected. Investors have taken note as the Financial Select Sector SPDR Fund (XLF), an exchange-traded fund that tracks the sector, is up 3.5% since the last Fed meeting.

The names of health and consumer staples have long been among Wilson’s favorites, given that these “defensive quality sectors” should hold up well if growth disappoints. These sectors are made up of companies that have a knack for succeeding in any environment, given the relatively low elasticity of demand for their products. In other words, consumers will need their products, even if the growth disappoints.

Investors can add exposure to these two sectors through a pair of ETFs: the Health Care Select Sector SPDR Fund (XLV) and the Consumer Staples Select Sector SPDR Fund (XLP).

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