Many investors are still looking at the current recession as an anomaly rather than as the end of a cycle. Chief Investment Officer Mike Wilson explains the implications.
Each week, Mike Wilson offers his perspective on the forces shaping the markets and how to separate the signal from the noise. Listen to his most recent episode and check out those of his colleagues from across Morgan Stanley Research.
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Welcome to Thoughts on the Market. I'm Mike Wilson, Chief Investment Officer and Chief, U.S. Equity Strategist for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the latest trends in the financial marketplace. It's Monday, June 22nd, at 11:30a.m. in New York. So let's get after it.
After publishing our mid-year outlook, it's customary for us to meet with as many clients as possible to discuss and debate. And last week, that's exactly what we did. Unfortunately, during this pandemic, we are no longer traveling to see clients in person. However, that has allowed us to have more interactions in a given week than normal, which helps us to gauge reception to our calls.
First, client reaction to our more constructive view on the economy and financial markets has evolved from outright dismissal, back in April, toward acceptance that the worst is behind us. However, there's still quite a bit of skepticism about the shape of the recovery and apprehension to embrace the typical pattern coming out of a recession.
More specifically, the consensus views this recession as being more akin to a natural disaster than the end of an economic cycle. Part of this stems from the belief that prior to Covid-19, the economy was in great shape and absent of any major excesses that could make it vulnerable to shocks. Some even believe the economy was still mid cycle and had years to run on the expansion. Had Covid-19 not appeared, we would still be firmly in the midst of the longest expansion on record. I disagree with that premise wholeheartedly and believe the U.S. economic cycle was very much showing its age at the end of last year, making it vulnerable to any shock, much less a global pandemic.
What this means from an investment perspective is that many clients are still embracing a late cycle playbook, as they view the current recession as more of an inconvenient interruption in an ongoing expansion. In short, they think the recession we are experiencing is not a true end of the cycle. Therefore, they remain overweight high quality large cap growth and defensive stocks while still shying away from small caps and economically sensitive stocks that tend to do better at the beginning of a new economic expansion.
This view also ties in very nicely with another area of pushback we received to our outlook: that long term interest rates can move higher in the face of quantitative easing and other forms of extraordinary central bank intervention. If there is a market with a stronger consensus view than lower for longer interest rates, I'm not sure what it is. Of course, after 10 years of extraordinary monetary policy and intervention, it's no wonder that investors are unwilling to fight this very well-established and powerful trend in long term rates. However, it's my contention that this lower trend in interest rates has led to overcrowding by investors in certain types of stocks that do better when rates are low.
In my view, there lies the opportunity. Investing is not just about trying to forecast economic and earnings growth, but it's also about understanding what's already priced. Many of the great investments of the past decade are still crowded because the fundamental and interest rate trends that have made these investments great are now well understood and accepted. That means the bigger opportunities are in investments that would benefit from a change in these base assumptions about the cycle, and interest rates in particular.
The bottom line is that Covid-19 fears are still present in every conversation with clients. But consensus still seems to expect a slower recovery and ultimately a return to a low growth, low rate world where the market will pay a high premium for large cap growth and high quality stocks. A new economic cycle argues against such an outcome, which means the real opportunity for investors is to go against the trends and look for stocks that are more economically sensitive and positively geared to higher growth and higher interest rates. That means small caps, financials, consumer durables, materials, industrials, and even energy stocks.
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