Thomson Reuters
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- In a major shift, investors are starting to place a greater premium on stock valuation over earnings growth as a performance factor, according to Morgan Stanley's equity strategists.
- They forecast that the market will be choppy in 2019 due to a slowdown in earnings growth, and recommend sectors of the market where the cheapest value relative to fundamentals can be found.
In the perennial tussle between value and growth stocks, Morgan Stanley has picked a winner.
In 2019 - and for the foreseeable future after that - the firm's equity strategists are recommending a preference for stocks that trade at cheaper prices relative to fundamentals like earnings. And Morgan Stanley says this will come at the expense of companies offering strong profit growth.
It's a major shift from the dynamic that's played out throughout the nearly 10-year bull market. An investor who followed this advice at the start of the bull run would have missed out on the far greater returns that were produced by growth stocks.
"From a style perspective, we think there is a major leadership change occurring from growth to value which could be more long lasting than most appreciate," Mike Wilson, the chief US equity strategist, said in a note.
The rally in tech stocks that fizzled out in October was proof of the shift that's taking place. At the same time, value stocks are outperforming growth. Since September 27, the Russell Large Cap Growth Index has bested its large-cap value counterpart by 800 basis points.
Zooming further out to December 2016, the growth index is the clear winner with 2,100 basis points of outperformance. And so, Wilson isn't counting out growth stocks completely.
What is changing, however, is that both real and nominal interest rates - including the yields on safer assets like Treasurys - are on the rise, while growth stocks are under pressure. The combination of these factors has led the market to put a premium on valuation as a factor for performance.
"The bottom line is that investors need to pay more attention to valuation now, especially for over loved growth stories that are effectively the longest duration assets in the world," Wilson said.
This approach will be handy if Wilson's central thesis - that stocks are in a rolling, drawn-out bear market - prevails in the new year.
He forecasts a choppy ride for investors in the new year, with the S&P 500 most likely ending at 2,750, but falling to 2,400 in the worst-case scenario and surging to 3,000 in the most bullish outcome. The volatility should be driven by a "material slowdown in earnings growth," the opposite of which has catapulted growth stocks during this bull market.
"At a high level, we are looking to be overweight a mix of defensives and value cyclicals while being underweight expensive cyclicals and sectors where earnings revisions may have greater relative downside," Wilson said.
To that end, Morgan Stanley is overweight consumer staples, energy, financials, and utilities.