- Morgan Stanley’s equity strategist Mike Wilson has been warning of a impending correction to the stock market for months.
- In this environment, Wilson advocates investors generate alpha through stock selection.
- We break down Morgan Stanley’s top 25 stock picks that are set outperform regardless of the macro backdrop.
- See more stories on Insider’s business page.
In recent weeks, a number of leading strategists and analysts have been calling for a correction in the US stock market, as valuations remain elevated.
One of the analysts with the strongest conviction on this call is Morgan Stanley’s chief equity strategist Mike Wilson.
Wilson, who predicted the last two market sell-offs, has been telling investors they are in the mid-cycle transition phase of a market cycle, an environment in which equities trading can get choppy.
He first made a correction call of between 10% and 20% in May this year and has continued to reiterate this view in recent months.
“We think that 2021 will be similar for investors – flattish returns for the year with a 10-20%+ correction along the way,” said Wilson in May.
Wilson’s take on the market centers around the potential for two different macroeconomic regimes that could result in a rolling correction that will eventually hit the S&P 500. One scenario is more severe than the other.
The first is the “fire scenario”, where thewould remove monetary accommodation in response to an overheating economy. This would lead to a healthy 10% correction in the S&P 500, Wilson said.
The second is the “ice scenario”, where earnings revisions and macro data points decelerate amid supply chain challenges, margin pressure and demand pull forward. This case would be more destructive, and could result in a 20%-plus correction, Wilson said.
September was already a tricky month for US equity investors, with the S&P 500 down 4% and the NASDAQ down nearly 5%, as investors assessed the impact of a number of factors, from the potential default of China’s second largest property developer Evergrande to the raising of the debt ceiling and slowing global growth expectations.
Wilson’s two scenarios suggest an even more uncomfortable environment for US investors in coming months. Even so, analysts at Morgan Stanley have identified a batch of stocks that have room for outperformance regardless of the macro environment.
In a new research note released on September 27, Wilson alongside analysts Michelle Weaver and Andrew Pauker lay out 25 stocks to buy that are set drive outperformance based on companies that fit with the bank’s “self help” theme – that is to say, those companies that are taking internal initiatives, such as changes to management and governance and don’t rely solely on the stage of the economic cycle or an uplift in a bullish equity market environment.
“Importantly, however, we continue to believe that investors can generate alpha through stock selection,” said Weaver in the report. “An index-level correction would also create more runway for stocks to outperform.”
More broadly the analysts are recommending a barbell approach, with healthcare and staples stocks to protect from the ice scenario, and financials to participate in the fire scenario, in which rates could move higher.
The 25 stocks are selected using the firm’s Risk Reward platform. They first screened for stocks that have positive exposure to the self-help theme and that are rated a buy. Once a list of stocks was established, the team spoke to each of the stock’s analysts to determine that the company’s self help levers were part of their bullish view.
“Finally, we considered relative value and each stock’s overall risk reward profile to determine the final list of 25 stocks,” Weaver said.
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