Ever since the turmoil earlier this year, the U.S. stocks markets have been on a relentless upward march, with both the S&P 500 and the Nasdaq making new all-time highs.
However, since the start of September, both of these benchmark indices have undergone a considerable pullback, prompting some speculation that the top of the market might have already been reached.
A recent research note from Morgan Stanley’s (NYSE:MS) equity department discussed whether this correction should cause investors to be worried about the state of the market.
Just a bump in the road
Morgan Stanley’s equity research department, led by Chief Equity Strategist Mike Wilson, caused some skepticism earlier this year when it announced that the March financial crash would mark the beginning of a new bull market, but so far, it’s hard to find fault with their thesis. Wilson sees the September slowdown as a normal bull market pullback.
To support this point of view, the note points to the fact that the stocks that have led the recent pullback are the very same stocks that benefited the most from the imposition of lockdowns – the technology sector. The Nasdaq is currently trading down around 7% from its recent all-time high. It is therefore perhaps unsurprising that the most expensive stocks have experienced the biggest valuation corrections.
If Wilson is right that this is indeed just a bump in the road for an already expensive market, then that introduces a difficult conundrum for investors: should they take the plunge to avoid missing out on future gains, or should they wait for a better entry point?
Political risk continues to weigh heavily on these discussions, as both the passage of a congressional fiscal deal and the outcome of the U.S. presidential election are currently big uncertainties. The note recommends that investors trade carefully around these events and focus on less glamorous sectors:
“We remain focused on stocks and sectors that will exhibit the most operating leverage next year as the economy continues to reopen. This leads us to smaller capitalization stocks in the materials, industrials, financial, and consumer discretionary sectors. One area in particular to keep in mind is consumer services, things that you can’t consume or experience today because that part of the economy remains effectively closed.
Some examples include travel and leisure, restaurants, and building activities. Finally, I’ve been highlighting financials as the best way to participate in rising long term interest rates that should occur once we get through the congressional impasse on fiscal spending and the election is concluded. Bottom line, be patient and selective with new purchases over the next few weeks and months”.
Of course, value investors should not be concerned about missing out on gains in an overheated market, and instead should focus on looking to buy cheaply priced assets with a wide margin of safety. Look after the downside and the upside will eventually look after itself.
Disclosure: The author owns no stocks mentioned.
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About the author:
Stepan Lavrouk is a financial writer with a background in equity research and macro trading. Specific investing interests include energy, fundamental geoeconomic analysis and biotechnology. He holds a bachelor of science degree from Trinity College Dublin.