Morgan Stanley equity strategist Michael Wilson sees volatility ahead for equity markets and, in response, provided a list of U.S. stocks that will be very palatable to risk-conscious investors.
Mr. Wilson has two major concerns as 2022 begins. One, he sees rising bond yields and tighter monetary conditions reducing the attractiveness of high growth, high valuation speculative stocks. Two, he expects slowing U.S. economic growth to represent a significant headwind to profit growth.
The strategist notes that the recent move higher in inflation-adjusted 10-year bond yields is one of the sharpest on record. These rising risk-free bond yields make speculative stocks less attractive and he estimates that the most expensive U.S. stocks have dropped 40 per cent from the peaks as a result.
Central banks are set to reduce asset market purchases and raise rates. “We’re entering into a tighter [monetary] policy regime, which historically has meant lower [equity market] returns and more uncertainty at the index level,” he wrote in a research report.
Unlike the taper tantrum in 2013, the imminent tightening of monetary policy will occur when economic and profit growth are slowing. Mr. Wilson believes that peak corporate earnings growth is six months behind us. He also cites the forward-looking new orders component of the monthly survey of major manufacturing companies (PMIs) as an indicator that the pace of U.S. growth is set to slow.
Morgan Stanley is not overly concerned about the U.S. economy but Mr. Wilson’s statements about markets sound rather dire. “If we’re right about PMIs falling further over the next few months, stocks still have material downside before this correction is over,” he wrote. “PMIs, economic and earnings growth will decelerate further than investors expect during the first half of 2022.″
To combat expected volatility, the strategist has compiled a list of defensive stocks: those with the most reliable earnings and attractive valuations. These are large cap stocks where in each case, price to earnings ratios are below the 75th percentile relative to their 10-year average, analysts largely agree on the pace of future profit growth (the technical term is ‘low earnings estimate dispersion’ relative to history), profit growth consistency is in the top half of the relevant sector, and the company is rated overweight by Morgan Stanley analysts.
The stocks in the list are Comcast Corp., Meta Platforms Inc., YUM Brands Inc., Monster Beverage Corp., Mondelez International Inc., Philip Morris International Inc., Exxon Mobil Corp., State Street Corp., Medtronic Inc., CVS Health Corp., Northrup Grumman Corp., Hubspot Inc., Paypal Holdings Inc., NetApp Inc., Cognizant Technology Solutions Corp., Ball Corp. and American Electric Power Co.
This is my favourite type of stock screen. Investors are unlikely to double their money in two years in any of them, but they have historically been able to grind out solid profit growth no matter what the market backdrop.
— Scott Barlow, Globe and Mail market strategist
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Ask Globe Investor
Question: Can you please explain why Firm Capital has been trending down from over $15 a month ago to the low $14s today. Should I ditch it now after I bought when you mentioned it a while ago? – B. Yuen
Answer: Actually, I first recommended Firm Capital (FC-T) in January 2004 at $11.30 in my Income Investor newsletter. Over the years it has almost always traded in a range from $10-15. The reason to own it is the steady income in provides, not for capital gains potential.
The price is down from the $15 range because of a combination of factors, the most important of which is rising interest rates, which will move higher in 2022 as the Federal Reserve Board and, presumably, the Bank of Canada move to fight inflation. There is nothing wrong with the fundamental strength of the company.
I have owned the stock ever since I recommended it and still do. If cash flow is your primary objective, you should just ignore the day-to-day price fluctuations and keep collecting the monthly dividend.
On the other hand, if you’re investing for capital gains you never should have bought this stork in the first place, as I have always tried to make clear. If that’s the case, by all means “ditch it”. But if you are looking for steady, predictable income, buy more when the price drops.
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Compiled by Globe Investor Staff