Morgan Stanley: "Three major risks" exist in the US stock market, continue to recommend clustering or defensive strategies

A strong economy is not good for stocks, while a weak economy can actually drive the stock market bull?

Morgan Stanley pointed out: Currently, we are more like in the "late stage of the cycle", often with a weak economy but a bullish stock market. Specifically, when the economy slows down due to the Fed's earlier tightening policies, investors tend to expect the Fed to cut interest rates in the future, pushing up stock market valuations. As price-to-earnings ratios and other valuation indicators soar, the current question is: "Will the speed of valuation decline exceed the speed of earnings growth, leading to a pullback in the U.S. stock market?"

Morgan Stanley stated that in fact, the valuation decline of most stocks has already exceeded their earnings growth, which is why stock selection is so important for active investors this year.

Michael Wilson, Chief U.S. Stock Strategist at Morgan Stanley, pointed out that the current U.S. stock market mainly faces three major risks:

1. Inflation and economic growth returning to an upward trajectory, leading to the Fed reconsidering rate hikes. Currently, we believe this scenario is unlikely, and both the bond market and stock market seem to have minimized the risk of this outcome. We expect that the result of growth picking up again will lead to a broadening rally in stocks to include small caps, low-quality consumer cyclicals, regional banks, transportation, and other sectors that have underperformed in the past two years. It is not yet clear whether this will benefit the S&P 500 index, as Fed rate hikes could weigh on the valuations of tech giants.

2. Deterioration in liquidity conditions leading to outflows from the stock market. One major risk in this regard is related to the funding source of government extraordinary deficits. Monitoring the term premium on government bonds is a good way to monitor this risk, and currently the term premium remains close to zero. If the term premium rises as it did last autumn, we expect a broad decline in U.S. stocks, with only a few stocks performing well. Given the current ample liquidity, reverse repos and the Fed's gradual exit from tightening policies, liquidity concerns are not a worry at the moment.

3. Market panic about economic growth, enough to turn bad economic data into unfavorable news for stock valuations. We believe this is the most likely risk for U.S. stocks to occur, in which case, large-cap quality stocks and defensive stocks may perform better.

Wilson pointed out that the Economic Surprises Index has been declining since the beginning of this year, and the large-scale fiscal spending and rate tightening policies in the U.S. are putting pressure on companies and consumers, which is unsustainable. Investors have recognized this, which is why they are rushing to buy the few companies that are performing well in this environment. Unless the bond market rebounds by raising the term premium, or economic growth slows down in a more meaningful way, we expect the situation of a rise in a few stocks and a decline in most stocks to continue. Therefore, we continue to recommend holding large-cap quality growth stocks and defensive stocks, while reducing exposure to cyclical stocks