Stocks showing exhaustion and nearing correction, Morgan Stanley says

A
trader works at the NYSE on Feb. 5. Morgan Stanley forecasts a
worse correction is coming.
Brendan
McDermid/Reuters

• The stock market is headed for a correction bigger than
  the February sell-off, Morgan Stanley’s equity strategists
  said. 
• A rotation to more defensive sectors is gaining
  traction, and the recent decline in tech stocks is a sign of
  market exhaustion, they said. 
• Michael Wilson, the chief equity strategist, has said
  stocks are in a rolling bear market this year.

A stock market selloff worse than the February correction is
coming, Morgan Stanley’s equity strategists forecast.

Earlier in July, they advised clients to turn defensive on the
market, in preparation for a rotation to sectors like utilities.
They also
downgraded the tech sector, making two decisions that even
they acknowledged many clients weren’t excited about.

But the team led by Michael Wilson showed no sign of backing down
on their views in their weekly note on Monday. In fact, the
recent sell-off in tech, which led stocks lower on Monday, only
confirmed that the rotation to more defensive sectors was gaining
traction, Wilson said. 

“The bottom line for us is that we think the selling has just
begun and this correction will be biggest since the one we
experienced in February,” Wilson said. “However, it could very
well have a greater negative impact on the average portfolio if
it’s centered on tech, consumer discretionary and small caps, as
we expect.”

Morgan Stanley

It didn’t help that last week,
Facebook and Netflix missed
earnings expectations, with the social-media network setting a
record for the
biggest one-day valuation wipeout. Netflix, meanwhile,
tumbled into a
bear market on Monday. 

Because the damage was mostly contained to the stocks with
disappointing earnings, investors got “an even greater false
sense of security in the market,” Wilson said. 

However, a strong
GDP report on Friday and
Amazon’s strong earnings left investors wondering what
to look forward to. By then, “the market appeared finally
exhausted.”

“The selling started slowly, built steadily, and left the biggest
winners of the year down the most,” Wilson said. 

His observations are based on the broader view that the stock
market is in a rolling bear market this year — a
tougher environment to make money in.

“Perhaps the best way to express our rolling bear market view may
be to simply overweight value vs growth as we are currently
recommending in our sector weights,” Wilson said.

Morgan Stanley is overweight utilities, energy, industrials, and
financials.

Wilson added that while this recommendation may mean ditching the
popular momentum stocks that have led the market higher, it’s
worth it at this stage. He noted that the outperformance gap
between large-cap growth and value stocks is at its widest since
the dotcom bubble. This gap isn’t “justified” by forward growth
and earnings expectations, he added. 

Morgan Stanley