Morgan Stanley's Mike Wilson says the S&P 500 is liable to catch down to a weaker equity market, and he expects quality stocks to lead the recovery. Separately, Goldman Sachs reports that cross-asset positioning has turned more defensive.
Most stocks have been in a correction for months, even as the S&P 500 has only pulled back a few percentage points. Morgan Stanley chief equity strategist Mike Wilson is betting the high-quality S&P 500 is liable to catch down to the rest of the equity complex, and he sees that as the time to add risk.
Wilson expects quality stocks to lead the recovery. He says the catch-down could happen fast, or it could be a slow bleed.
Quality stocks pull ahead of the equal-weight index
Quality stocks, which Wilson defines as those with superior profitability, strong balance sheets and predictable earnings, have been in motion since mid-August. They have rallied 6% over that period, while the broader equal-weight S&P 500 index has lost around 4%.
Earnings revisions explain much of the gap. The difference in earnings revision breadth between high- and low-quality stocks has expanded to 10%, the second-widest since 2010. Historically, when that gap sat in the top quintile, higher-quality stocks outperformed by an average 7.5% over the following year.
Tight financial conditions do the Fed's work
Wilson also argues that tightening financial conditions are doing some of the heavy lifting for the Fed. As a result, Federal Reserve Chair Kevin Warsh does not need to hike the federal funds rate, in Wilson's view. A stronger dollar, higher energy prices and higher bond yields are behind the tightest financial conditions since 2022.
The next step for Warsh matters for financials. If he acknowledges the negative growth effects, that would probably help rate-sensitive areas of the market. If he keeps his hawkish focus on inflation, those stocks may continue to underperform, Wilson said.
Goldman sees defensive positioning
Goldman Sachs told clients that its sentiment and positioning indicator fell to the 46th percentile, the lowest level since April. Analyst Christian Mueller-Glissmann pointed to stronger fixed income fund flows and increased positioning in safe haven assets such as gold and the yen.
The bank also warned that high investor conviction could lead to bigger market swings. Momentum ETFs recorded an estimated $5.1 billion of outflows in September, and hedge fund net leverage has fallen sharply in recent days.
Sources: MarketWatch, Investing.com
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