Eighteen months ago, thousands of us left the annual convention in Nashville and were ready to attack a new year. We could never have imagined what was in store for us as the horrific COVID-19 pandemic came on strong and just now seems to be letting up. You, your teams, and the entire world for that matter have experienced changes and disruptions that no one will soon forget. The same can certainly be said for the economy and the investment markets in the same time span.
As such, we want to take a break from sharing financial planning guidance so we can provide some perspective from Morgan Stanley’s Global Investment Committee. The Global Investment Committee (GIC) is a group of seasoned investment professionals from Morgan Stanley & Co. and Morgan Stanley Wealth Management who meet regularly to discuss the global economy and markets. The committee determines the investment outlook that guides our advice to clients. They continually monitor developing economic and market conditions, review tactical outlooks and recommend asset allocation model weightings, as well as produce a suite of strategy, analysis, commentary, portfolio positioning suggestions and other reports and broadcasts.
Below is an excerpt from a recent report as we enter the second half of 2021:
Each year at this time, our macro research team gets together and updates our 12-month forecasts. It’s also a review of our calendar year-ahead outlook: what we got right, and what we got wrong. For US equities, our sector and style preferences proved out, but our forecast for the S&P 500 Index was too conservative. In fact, the S&P 500 is already trading well above our year-end 2021 price target of 3,900. Even so, we did not raise that target. Instead, we are doubling down on why we think there’s no upside for the main US equity index for the rest of the year.
To start with, we think valuation will be a headwind as we leave the early cycle part of this recovery. We call it the midcycle transition and it tends to coincide with the peak rate of change in policy and growth. Typically during this period, the price/earnings multiple for the S&P 500 falls by approximately 20%. So far, it’s declined just 5%. Next, long-term interest rates have moved significantly higher this year, and many of the most expensive and speculative parts of the equity market have derated. In addition, earnings expectations have finally arrived at the reality of this V-shaped recovery. Specifically, estimates now reflect the strong operating leverage we anticipated. The reopening of the economy is likely to put upward pressure on costs and downward pressure on profit margins. Finally, higher corporate taxes are likely coming. While it’s unlikely the Biden administration gets the full hike to 28% it is seeking, we do expect a compromise to be enacted. We estimate these changes will negatively affect S&P 500 earnings next year by 5%.
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The bottom line is that for equity investors, sector and style preferences along with superior stock selection will be necessary for success this year. Along those lines, we favor reflationary beneficiaries such as financials and materials rather than reopening plays like consumer discretionary stocks, which carry high execution and margin risk. We also prefer quality stocks with relatively more stable earnings such as consumer staples, which tend to outperform during midcycle transitions. Similarly, reasonably priced growth stocks offer dependable performance in midcycle transitions. In that regard, look toward health care and parts of communication services rather than technology, where valuations remain rich. Finally, be selective in cyclicals, which have had a powerful run, as we expect the rate of change on growth and inflation to peak this summer.
The above guidance may be similar to what you are getting from your own financial advisors. Regardless, if you would like to get a full copy of our market commentaries from time to time or to schedule a time to talk more about your financial planning and investment management, please reach out. We are here to help you. In the meantime, we hope you enjoy some quiet time as the beginning of what hopes to be a more normal season nears.
About The Authors
Keith Norris, First Vice President and Financial Advisor, and Matt Kuerzi, Vice President and Financial Advisor, are co-founders of The Derby City Group at Morgan Stanley in Louisville, Kentucky. They have combined over 40 years of experience helping families with their financial planning.1 In 2019, Matt was recognized by Forbes in their first ever list of “Best-In-State Next-Gen Advisors”. He can be reached directly at (502) 394-4094 or email@example.com.
Branch address: 4969 U.S. Highway 42, Suite 1200, Louisville, KY 40222
(1) Keith Norris, First Vice President, Financial Advisor, experienced in the financial services industry since 1997. Matt Kuerzi, Vice President, Financial Advisor, experienced in the financial services industry since 2002.
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Source: Forbes Magazine (September 2019). Data provided by SHOOKTM Research, LLC. Data as of 3/31/19. SHOOK considered Financial Advisors born in 1980 or later with a minimum 4 years relevant experience, who have: built their own practices and lead their teams; joined teams and are viewed as future leadership; or a combination of both. Ranking algorithm is based on qualitative measures: telephone and in-person interviews, client retention, industry experience, credentials, review of compliance records, firm nominations; and quantitative criteria, such as: assets under management and revenue generated for their firms. Investment performance is not a criterion because client objectives and risk tolerances vary, and advisors rarely have audited performance reports. Rankings are based on the opinions of SHOOK Research, LLC, which does not receive compensation from the advisors or their firms in exchange for placement on a ranking. The rating may not be representative of any one client’s experience and is not indicative of the Financial Advisor’s future performance. Neither Morgan Stanley Smith Barney LLC nor its Financial Advisors or Private Wealth Advisors pays a fee to Forbes or SHOOK Research in exchange for the ranking. For more information see www.SHOOKresearch.com.
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