S&P 500 upside capped from current levels; Morgan Stanley says valuations remain high

With the upside capped, Morgan Stanley believes buyers ought to give attention to reflationary beneficiaries like Financials and Supplies.
(Picture: REUTERS)

With the S&P 500 index already above Morgan Stanley’s year-end goal of three,900, the worldwide brokerage and analysis agency believes there’s no room left for the index to rise additional. “We proceed to consider valuations are too excessive and can alter materially decrease over the following six months,” Mike Wilson, Chief Funding Officer and Chief US Fairness Strategist for Morgan Stanley mentioned in a podcast. S&P 500 closed at 4,127 on Tuesday. Thus far this 12 months the index has managed to leap practically 12%.

“The first motive we predict valuation will show to be a headwind, in our view, is we’ve left the early cycle a part of this restoration,” Mike Wilson mentioned. He added that valuations are excessive as we enter the mid-cycle transition section. Throughout this section, Wilson added that the worth to earnings a number of for the S&P 500 falls by roughly 20%. The identical is down simply 5% to date. Additional, the uptick in long-term rates of interest are additionally among the many elements which can be anticipated to restrict the upside. Whereas rates of interest are up the costliest and speculative elements of the fairness market have de-rated considerably. “That tells us the de-rating is nicely underway and can finally drive the a number of for the S&P 500 down by one other 10-15%,” Mike Wilson added.

Now, because the US financial system makes an attempt to leap again to the previous regular, earnings expectations are catching up. Firms are turning worthwhile, helped by the coverage assist prolonged amid the pandemic. “However now the reopening of the financial system is more likely to put upward stress on prices and downward stress on margins. It will come as a shock to now lofty earnings estimates, in our view,” the US fairness strategist mentioned. This will likely be additional impacted by the anticipated improve in company taxes, as proposed by the present Joe Biden administration. Morgan Stanley expects a change in company taxes to negatively have an effect on S&P 500 earnings estimates for subsequent 12 months by roughly 5%.

With the upside capped, Morgan Stanley believes buyers ought to give attention to reflationary beneficiaries like Financials and Supplies, somewhat than reopening performs like client discretionary shares that carry excessive execution and margin danger. “We additionally favour high quality shares with comparatively secure earnings, like client staples, which are likely to do higher throughout mid-cycle transitions. Equally, fairly priced progress shares provide reliable efficiency in a mid-cycle transition interval. In that regard, look towards Well being Care and elements of Communication Companies somewhat than Expertise, the place valuations stay wealthy, and payback in demand from final 12 months stays underappreciated,” they added. The brokerage agency has now downgraded Industrials to equal weight and closed its underweight on small caps after a somewhat massive 12% underperformance over the previous two months.