Stock market investors are complacent and face likely correction

Investors are being complacent as a “likely correction”
nears, Morgan Stanley says.
Reuters

• As investors take time off during the summer, they’re
  also taking their eyes off several things that point to a
  “likely correction” in the stock market, according to Morgan
  Stanley‘s global investment committee. 
• There’s proof of their complacency in the S&P 500
  put/call ratio, which has risen in the past month but remains
  below average. 
• “Consider taking profits in growth and
  momentum-oriented sectors,” Morgan Stanley told
  clients. 

Stocks are within reach of all-time highs, but Morgan
Stanley’s global investment committee isn’t getting ready to pop
any champagne bottles. 

In fact, the committee is warning that investors have become
complacent by pricing in continued US economic growth against a
backdrop of several potential setbacks. 

Specifically, the committee is flagging the fact
that investors aren’t paying up to hedge against a market
downturn. The S&P 500 put/call ratio, or the share of
option-market bets on a rally compared to bets on a decline, has
risen in the past month but is still below average.

Morgan
Stanley

Also, stock-market volatility, as measured by the CBOE Volatility
Index (or VIX), is near cycle lows.

After factoring in the flattening yield curve, and a wave of
geopolitical headlines (save for
Turkey) that haven’t spooked investors, Morgan Stanley found
the recipe for complacency.

“The Global Investment Committee believes that this combination,
especially in a seasonally weak period for stocks and ahead of
the midterm election, creates a good opportunity to become more
defensive,” Lisa Shalett, Morgan Stanley’s head of wealth
management, said in a note on Monday. 

“Consider taking profits in growth and momentum-oriented sectors;
skew toward defensive stocks and those with valuation support as
a likely correction approaches,” Shalett said. 

Michael Wilson, Morgan Stanley’s chief US equity strategist, has
also advised investors to get more defensive, and
has downgraded
the tech sector while upgrading utilities. Even before the
market’s correction in February, Wilson said stocks were in a
rolling, drawn-out bear market in which it becomes harder to make
money.

There are equally factors that explain why investors have held
the market up. US
gross domestic product in the second quarter grew at the
fastest pace since 2014, the
unemployment rate is at the lowest since 2000, S&P 500
earnings are still growing, and
corporate buybacks are on pace for an annual record.

But Shalett finds holes in each of these reasons, which investors
may be turning a blind eye to. 

They include the escalating trade dispute between the US and
China. “In our view, a trade conflict impacting more than $200
billion of goods would likely prove recessionary,” she said.

Also, she observed “meaningful declines and downside misses” in
data on US manufacturing, the services sector, payrolls,
construction spending, auto sales, and consumer confidence during
the past two weeks. 

The reality of slower economic growth in the second half of the
year should soon hit prospects for earnings growth,  Shalett
forecast. 

“We are concerned that this complacency is built on tax cuts and
buyback-induced gains in earnings per share and puts investors at
risk if the economy slows, the trade situation worsens, the Fed
continues to tighten and fiscal profligacy continues unabated,”
she said.

“Seasonal factors and the midterm elections are further potential
flash points for a market that we increasingly see as
vulnerable.”