- Major US stock indexes are in a "rolling correction" amid a "classic" midpoint transition cycle, Morgan Stanley said.
- During this period of transition, stocks will remain vulnerable.
- Morgan Stanley analysts say they favor defensive position and GARP – growth at a reasonable price.
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Major US stock indexes are in a "rolling correction" despite notching a series of new highs, as the market cycle transitions to its midpoint, Morgan Stanley analysts said.
As investors rotate away from higher risk names and as market breadth declines, major indexes will remain vulnerable, analysts led by equity strategist Michael Wilson said in the note.
"Under the surface, financial markets have taken on a much more defensive posture," the note said.
So far, Morgan Stanley has taken a less optimistic view of the markets compared to other banks. The analysts said that they fully expect the transition and subsequent corrections to be complete by the end of this year.
"It's common for the market to rotate away from early cycle winners toward larger cap, higher quality stocks," the note said, adding that the rotation away from previous market leaders and small caps are now underway.
This would mean, according to Morgan Stanley, a forward price-to-earnings that is roughly 18x compared to the current 21.3x.
"Push back to that view has been strong but our conviction remains high based on other moves we have observed in the markets," the note said.
Bloomberg, Morgan Stanley Research
Most have blamed extreme positioning and short-covering as well as the Federal Reserve's hawkishness after its June FOMC meeting, the note said, though the analysts believe otherwise.
"We have taken a different view than the consensus citing the potential for a slow down in the second half of the year due to monetary aggregates' growth decelerating and peak rate of change on economic and earnings revisions."
Given this, the note said Morgan Stanley will continue to favor quality and defensive positioning and GARP - growth at a reasonable price.