The risk of an economic downturn is now greater than the risk of inflation, according to Morgan Stanley. At the midpoint of the year, stocks were near all-time highs, mostly buoyed by a number of megacap tech stocks linked to artificial intelligence trading. The S&P 500 has risen nearly 15% this year, with more than 30 record closes along the way. But Morgan Stanley worries that poor market breadth, measuring the number of stocks that advance against decliners, is a sign that slow economic growth is a bigger risk than high inflation. As evidence, the Wall Street investment bank cites surprises in recent macroeconomic data. “With macro data generally coming in softer YTD, many lower and economically sensitive areas of the market have lagged, while higher quality mega lists have led the performance,” wrote Mike Wilson, equity strategist at Morgan Stanley. “In our view, this is a sign of the market becoming more focused on softening growth and less focused on inflation and (interest) rates,” Wilson said. While the relatively tech-heavy S&P 500 and Nasdaq Composite have risen nearly 15% and 17% respectively this year, the Dow Jones Industrial Average, which is less exposed to AI themes, is up nearly 5%. Meanwhile, the Russell 2000 also lagged. The small-cap index will only gain 0.5% in 2024. “This background synchronizes with our long-standing view that the current policy mix of heavy fiscal and higher forward rates is effectively slowing down many economic participants,” Wilson wrote. Of course, Morgan Stanley’s strategists aren’t expecting weak broads to herald weak returns. But he expects that the current market spread will be limited to high-quality, large-cap and defensive stocks, especially if a downturn is expected as the future scenario. “A growth fear is substantial enough to turn bad economic data into bad news for equity (price-to-earnings) multiples across the board,” Wilson said. “We think this is the most likely risk, and conversations with clients echo this view.” Here are some large-cap and quality defensive stocks with strong upward earnings revisions that could outperform, according to Morgan Stanley. This stock is in the top 1,000 stocks by market cap and scores in the top third of the high-quality composite reading. Burlington shares are up 25% this year, and the stock is overweight-rated by Morgan Stanley. On Monday, Bernstein notes that off-price retailers like Burlington will continue to outperform the retail sector. “We expect BURL to increase margins and ROIC in new stores, as well as profitability in existing businesses from improved purchasing and supply chain processes – we model ROIC as high as 10% by 2026,” wrote the company’s Aneesha Sherman. Monster Beverage appears on Morgan Stanley’s list. Stocks rated overweight are down more than 14% this year. A Jefferies note this month called Monster Beverage one of the company’s top choices in a bifurcated consumer economy, saying the brand has “the fewest for trade & private label.” Nvidia and HubSpot also appeared on Morgan Stanley’s screen.
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