Summary List Placement
With the end of COVID-19 nowhere near, it is hard to believe that the stock market is well into another bull run and the economy has entered into a new cycle.
Mike Wilson, the chief US equity strategist at Morgan Stanley, is among those who are optimistic about both. In a recent note, he said he expects a V-shaped economic recovery and its ripple effects on the stock market to persist so long as (1) people continue to adapt to the “new patterns of living and consumption” brought on by the pandemic, and (2) the Federal Reserve and government continue to provide sufficient monetary and fiscal support.
Given such a macro backdrop, Wilson believes the new bull market will be driven by higher earnings based on a mix of company sales growth and operating leverage.
In addition, his team was especially encouraged to see the median S&P 500 company cut their cost of goods sold as well as selling, general, and administrative expenses by 5.4% in the second quarter. He thinks this “sets the stage for better profits next year as the economy and topline recover.”
While earnings are likely to rise steadily, the combination of higher long-term rates and lower equity risk premiums (the returns investors get for taking on higher risks in the market) could bring price-to-earnings multiples lower, making valuations a headwind for earnings growth, the strategist warned.
As such, for the rest of the year, investors are more likely to find the most attractive opportunities in the market through stock-picking and style selection instead of buying the indices.
“…it will likely be harder to make money from here if one is simply long SPX or NDX futures as we don’t see a lot of upside or downside over the next three months for the S&P 500 or Nasdaq 100 indices based on valuation,” Wilson said. “To us, a bull market is when the breadth is good and many stocks are making new highs and leading the way.”
In addition to holding the view that handpicked stocks should do better than broader index beta, Wilson forecasts that small-cap stocks will outperform large-cap stocks over the next 12 months.
But his bigger conviction lies in investing in cyclical stocks over defensive stocks. He points out that there is “sustained acceleration” in inflation, personal income growth, and GDP growth along with continued improvement in PMIs, consumer sentiment, and rates. These all all tend to support cyclical outperformance, he added, including the chart below that shows cyclical sectors have broadly led the market’s returns since the bottom in March.
In a separate note, Wilson pinpointed the industrials sector as a preferred cyclical play. His team’s stock picks included Avis, Deere, and TransDigm Group.
“While we’ve had a substantial rebound in performance to date, long-term relative performance still sits at near-multi-generational lows,” Wilson said of cyclicals. “And we think GDP sensitive stocks with earnings upside are likely to be the most fertile ground for stock picking going forward.”
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Source:: Business Insider