Morgan Stanley’s funding chief and head U.S. fairness strategist Mike Wilson has been one in every of Wall Road’s greatest bears over the previous two years. And regardless of lacking the mark with lots of his extra pessimistic forecasts in 2023, he stays involved concerning the inventory market’s potential for returns transferring ahead.
By this time subsequent yr, Wilson believes the S&P 500 gained’t have moved a lot in any respect, rising simply 2% to 4,500. The slowing impact of years of inflation and rising rates of interest will finally depress the financial system and company earnings in 2024, the Wall Road veteran warns, and that may result in some ache for shares.
It’s an outlook meaning traders in broad market indexes may not make a lot of a revenue subsequent yr, however Wilson laid out a couple of methods they will juice their returns in a Monday observe to shoppers. He highlighted conventional defensive shares within the client staples and healthcare sectors that ought to carry out properly if a recession hits, in addition to “late cycle cyclical” performs within the vitality and transportation sectors. And surprisingly, Wilson additionally detailed some “select growth opportunities,” significantly in AI, that would supply long-term potential regardless of his near-term bearishness.
“The leading macro data suggests that we’re in a late cycle market environment,” he defined, referring to the interval earlier than a recession. However it’s additionally a “stock-picking environment.”
Close to-term earnings headwinds—and a inventory pickers’ market
Earlier than leaping into Wilson’s sector and inventory picks for 2024, it’s essential to element the reasoning behind his principally bearish outlook. First, Wilson famous that the financial system and inventory market have been extra resilient in 2023 than he anticipated. In January, the CIO predicted company revenue margins would deteriorate and the financial system would wrestle below the load of rising rates of interest and inflation, main the S&P 500 to finish 2023 at 3,900. However that’s a far cry from Monday’s degree above 4,400.
“The path of earnings growth for the S&P 500 has proven to be lower directionally this year, but we were too bearish in terms of expected magnitude of the decline,” he admitted Monday.
Nevertheless, Wilson attributed the shocking power out there to the outperformance of massive tech shares that did an “outstanding job on cost discipline and taking share in an economy supported by aggressive fiscal spending.”
Massive Tech’s rise has helped the S&P 500 recuperate from a dismal 2022 even amid a broad earnings recession for many public firms, that are nonetheless scuffling with inflation and rising borrowing prices. However Wilson warned that that is typical “late cycle behavior.”
“The question for investors at this stage is whether the leaders can drag the laggards up to their level of performance or if the laggards will eventually overwhelm the leaders’ ability to keep delivering in this challenging macro environment,” he wrote.
Wilson hinted that his view is the market’s laggards overwhelming their Massive Tech leaders is a extra seemingly situation, noting that fourth-quarter earnings estimates for each Massive Tech and the general market are declining—“an early indication of continued downside for 2024 consensus estimates.” He fears that client spending may also start to sluggish as fiscal stimulus from the pandemic period fades and the affect of the Federal Reserve’s rate of interest hikes over the previous 20 months weigh on “both corporate and consumer sentiment.”
The excellent news is that near-term uncertainty ought to give method to an “earnings recovery” in 2024 because the Fed cuts charges, but it surely gained’t be sufficient to offer traders the returns they’ve develop into accustomed to in latest many years. Wilson’s 2% anticipated annual return is much from the practically 7% common the S&P 500 has managed since 2000.
In fact, not everyone seems to be so bearish. The veteran strategist Ed Yardeni, founding father of Yardeni Analysis, believes the S&P 500 will soar over 22% to five,400 by year-end 2024. And UBS sees the index rising to 4,600, barely forward of Morgan Stanley’s outlook.
Nonetheless, with elevated odds of a weak yr within the inventory market, Wilson stated that 2024 may very well be the yr of the inventory picker. Investing in broad indexes is prone to be ineffective, however after the decline in lots of equities in 2023, there’s a “richer opportunity set under the surface of the market” in particular person shares with compelling valuations. “We think it’s prudent to deploy a stock picking approach,” he wrote.
Defensive names, late-cycle cyclical performs, and AI-era picks
In relation to inventory picks, with a recession doubtlessly on the best way, Wilson believes traders ought to look to traditional defensive shares. These are firms that supply crucial providers that aren’t as affected by financial cycles, together with client staples and healthcare. Even within the worst of instances, Individuals will nonetheless want to purchase toothpaste and go to the physician. And proof reveals that they’ll preserve smoking—and even smoke extra—too. Right here’s Morgan Stanley’s full checklist of conventional defensive shares for 2024.
Within the interval earlier than a recession hits, so-called “late cycle cyclical” shares additionally are likely to outperform their friends. With that in thoughts, Wilson highlighted airways, oil and fuel giants, and aerospace and protection leaders that would outperform in 2024.
Nevertheless, he additionally supplied a caveat: the checklist of late cycle cyclicals will start to underperform conventional defensive performs in 2024 if a recession does hit, as Morgan Stanley expects, so traders ought to preserve that in thoughts.
Lastly, Wilson threw in a curve ball for traders. Whereas development shares don’t normally carry out properly during times of rising rates of interest or recessions, the AI development is just too massive to disregard. Wilson famous that the know-how is prone to increase company margins and employee productiveness. “Our analysts see AI-based innovation creating new digital consumer use cases, driving incremental enterprise top-line and efficiency opportunities, and fostering tech diffusion across the economy,” he defined.
On high of that, if a recession does hit in 2024, it can seemingly lead the Fed to chop rates of interest. And development shares are likely to outperform during times when rates of interest are falling, even when it’s a new period of upper charges total.
The “pivot to more accommodative monetary policy should be constructive for equities,” Wilson wrote, including that “relief on interest rates as we progress through next year should also aid corporate and household sentiment which has remained subdued.”