- Last week's stock market slump was an "indiscriminate" sell-off that created oversold conditions, according to Mike Wilson, the chief US equity strategist of Morgan Stanley.
- He does not expect a swift recovery to all-time highs because of the unpredictable nature of the coronavirus outbreak.
- Wilson still recommends a four-part strategy that involves buying quality stocks and the most oversold names.
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Stocks began trading on Monday by attempting to recover from their worst week since the financial crisis.
As the novel coronavirus spread globally last week and claimed more lives, investors feared it would lower economic activity and trigger a recession.
But they are growing more confident in a lifeline that has been thrown their way throughout this bull market: coordinated central-bank intervention.
In these early innings of a market rally, Morgan Stanley's chief equity strategist doubts we'll see a v-shaped recovery that swiftly returns the S&P 500 to its old highs.
According to Mike Wilson, investors must keep in mind that the impact of the coronavirus will unfold over time and leave investors vulnerable to more volatility. For example, one of the unique challenges of this disease, named COVID-19, is that its symptoms do not manifest immediately. This means by the time people are diagnosed, it is often too late to prevent them from passing it on.
Wilson sees the virus outbreak being contained by March-end in his best-case scenario and persisting through Q3 in his worst case.
Either way, what investors should do now is bulk up after last week's "indiscriminate sell-off" that created oversold conditions, Wilson said.
In a note to clients on Monday, he listed four top-level criteria for the kinds of names to consider and included multiple examples within each.
1. Quality stocks with high growth potential
When the economy is in good shape, investors can afford to hold their noses over companies with tons of debt - so long as earnings are growing.
But during tough times, quality companies with strong balance sheets are more valuable for their superior ability to weather a recession.
Morgan Stanley identified the highest-quality stocks of the moment by screening Russell 1000 names in the top two quintiles of return on invested capital since the financial crisis.
Additionally, their long-term growth estimates are in the market's top-two quintiles. But their price-to-earnings-growth ratios are in the bottom two, indicating that investors foresee growth but do not have euphoric expectations.
Some of the stocks that survived these screens include Nike, Advance Auto Parts, BlackRock, and Dropbox.
2. Stocks with a technical edge
These are companies that fell from their one-year peaks by more than the market and yet managed to hold above their 200-day moving averages based on closing prices.
According to this technical analysis, Nvidia, Zillow, and AMD - which lost nearly a quarter of its value - are great buys now.
3. Cheap cyclical stocks
Investors who expect an economic rebound should seek out cyclical stocks with lower-than-average valuations relative to the broader market.
Stocks that fit this bill and are also buy-rated by Morgan Stanley's analysts include General Motors, Sherwin-Williams, and Deere.
4. The most oversold stocks
Finally, investors should consider the biggest under-performers during last week's carnage.
Morgan Stanley screened for stocks that underperformed the S&P 500 by at least 5% on both an absolute and beta-adjusted basis. They excluded stocks that sold off on earnings-related news, and focused mainly on sectors hurt by the coronavirus outbreak: consumption, travel, and industrial production.
Stock picks included Norwegian Cruise Line, Darden Restaurants, JetBlue, and Valmont Industries.