Morgan Stanley describes 3 reasons why equity investors should remain defensive

After the volatile start of the year, US stocks still have room to fall and investors need to maintain a defensive stance, Morgan Stanley said in a note Monday.

Banking strategists led by Michael Wilson said traders were becoming too “optimistic” given a few more weeks of bearishness on stock market forecasts.

“Winter is here and Punxsutawney Phil says we have at least six more weeks,” they said, repeating the warning from the end of January to play defensively. “We agree and we think it could even happen in the spring. The risk of profits is increasing for a wider part of the market than most investors expect, as growing stocks meet declining demand.

U.S. stocks have sparked in recent weeks as investors have come to terms with a more hawkish Federal Reserve determined to tighten monetary policy to cool inflation.

Here are three reasons why Morgan Stanley believes investors should remain defensive:

1. Earnings are slowing down

The percentage of fourth-quarter earnings that exceeded estimates so far returns to the long-term average of 5%, well below the 15% -20% seen in the last 18 months, which marked a “period of overprofits,” strategists said.

The key question now is whether we will return to the “normal” or we will first experience a period of insufficient profits – – ie. payback? ”they added.

This payback, they say, is likely to be in the first half of the year as fiscal stimulus fades, monetary policy tightens and demand catches up with markets.

“The audit of profits leads to breadth, and recent trends suggest that we are moving in that direction,” they said. “The companies most at risk of profit remain those businesses that have benefited most from the pandemic.”

2. Consumer confidence is in reserve
Over the past few weeks, strategists have seen companies – including Netflix, Facebook’s parent Meta and PayPal – that were not expected to see such payback profits after disappointing results and poor guidance. This suggests that the so-called payback may be deeper and wider than originally expected.

“Everyone has a little Peloton,” they said, citing the fitness company’s overestimation of future demand for its products and services. “We suspect that there will be more surprises on this front… Consumer confidence remains in reserve due to higher prices.”

In addition, strategists said there is growing evidence that consumers may simply be in a worse position to spend, even if they want to.

“Consumer costs are at risk and not everything is due to Omicron,” they said. “Instead, it is rather a combination of government transfers that take place as prices rise to levels of demand-wasting.”

3. Building inventory is not necessarily good for earnings

Banking strategists said that while stock recovery could boost economic growth, there is a risk if demand does not match supply. They also said they remained skeptical that this would eventually turn into a smooth “goldilocks transition”.

“We believe this could also reveal the large number of double orders in many industries,” they said. “Canceling orders will only worsen the already weakening demand.”

How should investors be positioned?

“What you need to do right now as an investor is look for areas that have already corrected or areas where demand is likely to be held back,” Wilson told CNBC on Monday, citing consumer services, healthcare and parts of technology as sectors. who have corrected. “This is the year of stock selection. It’s not an index anymore. “