The recent record highs on the US stock market have punished those who expect stocks to go down, but at least one prominent skeptic stands by his reputation.
Michael Wilson, chief US equity strategist at Morgan Stanley, said despite the recent reports on Wall Street, there are disastrous trends beneath the surface of major indices. These cautious signals indicate that the potential for a weakness is greater than that directly implied by the S & P 500
SPX, + 0.77%
and the Nasdaq Composite Index
COMP, + 0.91%
closed records on Monday.
"Over the past two months, the US stock market has become much more defensive and the value is showing more consistent performance relative to growth," he wrote in a note to clients. The shift to defensive sectors and value strategies, as well as "weak breathing space and underperformance among former technology leaders" are examples of the market "talking" loudly and being overshadowed by the recent gains of the indices.
message? he asked rhetorically, "The market seems (and rightly so) to be concerned that growth will slow this year and next. The reasons for the slowdown are obvious – tough comparisons, tightening of the Fed, rising cost pressures and the danger that trade tensions will become more consequential. In late July, Wilson wrote that the Wall Street rally warned signs of "fatigue" that investors should expect the biggest sell-off since the February correction, which is the Dow
DJIA, + 1.01%
officially left on Monday. In August, the Dow rose 2.5%, the S & P 2.9% and the Nasdaq 4.5%.
The investment bank predicted "a rolling bear market" and noted that "every sector in the S & P 500 has suffered a significant downgrade" except for technology and consumer discretionary stocks and small capitalization stocks. In a follow-up report, Wilson said the bull market – which is by far the longest in history – was in its "final innings" as these recent pristine segments of the market rally would likely see a similar decline.
Wilson affirmed this view in his most recent note, writing that "the conclusion is that the rolling bear market, which began in January, is the most vulnerable to open-ended US growth and small-cap stocks."
While recent stock gains were broad-based – of the 11 primary S & P 500 sectors, 10 of which were positive in August – defensive groups were notable winners. Telecommunications grew 5.1% a month, while healthcare grew 3.5%. So-called cyclical sectors, which tend to correlate more with the pace of economic growth, have lagged behind. The materials sector has increased by less than 0.5%, while industrials have risen by 0.8%. Energy stocks are busy at almost 3%.
A notable exception to the cyclical underperformance is the FAANG stock or the quintet of major technology and Internet stocks that have been reviving the market for years. The tech sector has risen by 5.6% per month, while retail names (including Amazon
AMZN, + 1.17%
NFLX, + 1.61%
) rose 3.9%
Winning in defensive sectors "was even more dramatic than we had imagined back then," Wilson said. "In fact, it was one of the most persistent and one-sided defensive turns we can remember outside of a true growth scare."
As this chart shows, the spread between cyclical and defensive stocks has dropped significantly in recent weeks. 19659017] Courtesy of Morgan Stanley
S & P 500 records at a time when defensive sectors are among the biggest winners, "is a rare combination of our experience," wrote Wilson. "We must respect the continued strength of US equity indices, but think that investors should continue to have a more defensive and value-oriented bias in their portfolios."
There are "definitely times when a good defense is needed to the game. We think that one of these times is now for investors."
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