Morgan Stanley warns: Do not chase the market

The focus will turn to the much-needed fourth round of US fiscal stimulus, talks on which have been delayed until politicians return from recess early next month. Picture: AFP

Concern about stretched valuations and the narrowly based leadership of nascent bull markets in US and Australian shares is building, with Morgan Stanley telling clients to switch to undervalued stocks.

Encouraged by the lowest US infection rates in months, stronger-than-expected economic data and reports that the Trump administration wants to fast-track coronavirus vaccines and treatments, investors have recently dabbled in “reopening trades” in the US sharemarket — airlines, cruise ship operators, ­casinos, restaurants, carmakers and home builders — yet the high-flying information technology and healthcare sectors continue to do most of the heavy lifting.

There was also a hint of a rotation to value and reopening trades on the Australian market on Tuesday as banks, property trusts and travel companies outperformed at the expense of some high-valuation stocks in the healthcare, consumer discretionary, staples and materials sectors.

But a broadbased pullback in value stocks — banks, travel and tourism — occurred on Wednesday as transition portfolios generated selling that pushed the S&P/ASX 200 down as much as 1.3 per cent to a six-day low of 6079.8, before an intraday bounce left it down 0.7 per cent at 6116.4 points.

Bell Potter’s Richard Copple­son says there were a number of transition portfolios as multiple value managers and at least one growth manager lost portfolio investment mandates.

“Given a number of value managers were losing mandates, it meant that there was no real buy support for a number of these stocks, so as a result the market was hit quite hard as most of these stocks ended up being sold into the market,” Coppleson says.

“The good news is as soon as the selling is completed, many so these stocks should rebound.”

And while the S&P/ASX 200 has continued to shy off its downward sloping 200-day moving average near 6150 (after briefly hitting a six-month high at 6199.2 on Tuesday), the S&P 500 has broken convincingly above its June peak ahead of a potentially supportive keynote address by US Federal Reserve chairman Jerome Powell at a virtual gathering of central bankers on Thursday.

Whether he paves the way for polices such as yield curve control, average inflation targeting and outcome-based guidance that would promote “lower for longer” interest rates remains to be seen.

Perhaps Powell won’t offer anything more than a commitment to do whatever it takes, but investors will continue to anticipate the much-needed fourth-round of US fiscal stimulus, talks on which have been delayed until politicians return from recess early next month.

If it greatly exceeds the expected $US2.5 trillion ($3.5 trillion), there may be supply worries for the US bond market that could push bond yields up enough to crimp the sharemarket, barring greater Fed buying. It could set the scene for the Fed to announce new policy initiatives at its September 15-16 meeting.

But after the US sharemarket hit a record high in the fastest comeback ever from a recession-linked bear market, Morgan Stanley Wealth Management chief investment officer Lisa Shalett is telling clients “not to chase this market”.

While seeing evidence of a V-shaped US economic recovery, acknowledging the “shock-and-awe” monetary and fiscal policies and believing “we are in a new bull market”, she says “extreme index concentration, skewed valuations and contrarian sentiment indicators give us pause, as does the fact the rebound has come from expanding valuation multiples”.

“While historically low real rates may mathematically justify extreme price/earnings ratios, expectations appear disconnected from reality,” she says.

“Investors seem to be looking past policy uncertainty and the possibility that secular growth stocks have benefited from demand pulled forward.”

In her view, investors should remain patient as markets consolidate during the next three months. In that environment, they should “consider harvesting tax losses to offset profits in overvalued outperformers. Rebalance toward small caps, value style and cyclicals.”

While positioned for a pro-cyclical rotation, Morgan Stanley Wealth Management’s Global Investment Committee is “sceptical that the market’s recovery is marking a full-blown expansion”.

“For starters, we note that the market milestone was reached against a backdrop of extreme index concentration and below average breadth,” Shalett says.

She notes that the five largest stocks by market capitalisation — the “category killers” in information technology and social media — comprise a historic 25 per cent of the index, a record ­rivalled only during so-called “Nifty 50” era of the late 1960s.

As a group, the big five are up more than 30 per cent for the year to date, but the median stock in the index is down 7 per cent, the value style is down 11 per cent and the financial sector is down 30 per cent, hitting all-time low relative price-to-earnings multiples.

“Although earnings revisions for the next 12 months are beginning to improve for most companies, that movement is off a terrible second quarter 2020 base in which aggregate earnings growth was off some 40 per cent,” Shalett says.