Morgan Stanley strategists recommend investors consider quality and defensive investments over growth due to concerns about the economic outlook.
Strategists pointed to a significant slowdown in consumer spending, a factor that has previously buoyed economic growth.
The firm emphasized that if household consumption continues to fade more than expected, it could signal broader economic issues. This concern is exacerbated by mixed macroeconomic data, with labor markets being a key focus.
Last week’s weaker-than-expected employment report has added to the perception of a weakening labor trend.
“Overall, the macro data suggest we are in a decelerating late-cycle economy,” economists said.
“In contrast, the micro data have been less resilient and are showing a more meaningful deterioration in growth, particularly in consumer services, where earnings revisions have recently broken down.”
This is especially evident among airlines, restaurants, hotels, auto, and credit card companies, suggesting that the slowdown is widespread rather than isolated. Even luxury goods companies have cited weakness in the US market.
Moreover, forward-looking macro survey data, such as the ISM Non-Manufacturing PMI and consumer confidence indices, have turned lower. The ISM survey, particularly its orders component, has shown softness, raising concerns about future economic activity.
Consumer confidence surveys, including those from the University of Michigan and the Conference Board, have also slowed, driven by declines in the current conditions component, which typically holds up better under economic pressure.
Another factor weighing on stocks is the sky-high valuations, ranking in the top decile of the past 20 years.
Morgan Stanley notes that earnings revisions breadth turned negative last month, with the last similar downturn occurring between July and October 2023, when market multiples declined significantly. Currently, the P/E ratio has dropped from 22x to 20x, and further declines in earnings revisions could drive valuations even lower.
“With our 12-month base case target multiple at 19x, the risk/reward for equities broadly remains unfavorable,” strategists said.
“Under the surface of the market, we continue to recommend a quality + defensive (rather than growth) bias.”