- The stock market is headed for a correction bigger than the February sell-off, Morgan Stanley (NYSE:MS)'s equity strategists said in a note Monday.
- A rotation to more-defensive sectors is gaining traction, and the recent decline in tech stocks is a sign of market exhaustion, they said.
- Michael Wilson, the firm's chief equity strategist, has said stocks are in a rolling bear market this year.
A stock market sell-off worse than the February correction is coming, Morgan Stanley's equity strategists forecast.
Earlier in July, they advised clients to turn defensive on the market in preparation for a rotation to sectors like utilities. They also downgraded the tech sector, making two decisions that even they acknowledged many clients weren't excited about.
But the team led by Michael Wilson showed no sign of backing down on its views in its weekly note on Monday. In fact, the recent sell-off in tech, which led stocks lower Monday, only confirmed that the rotation to more-defensive sectors was gaining traction, Wilson said.
"The bottom line for us is that we think the selling has just begun and this correction will be biggest since the one we experienced in February," Wilson said. "However, it could very well have a greater negative impact on the average portfolio if it's centered on tech, consumer discretionary and small caps, as we expect."
It didn't help that Facebook (NASDAQ:FB) and Netflix (NASDAQ:NFLX) missed earnings expectations last week, with the social-media network setting a record for the biggest one-day valuation wipeout. Netflix tumbled into a bear market on Monday.
Because the damage was mostly contained to the stocks with disappointing earnings, investors got "an even greater false sense of security in the market," Wilson said.
But a strong report of US gross domestic product on Friday and Amazon (NASDAQ:AMZN)'s strong earnings left investors wondering what to look forward to. By then, Wilson said, "the market appeared finally exhausted."
"The selling started slowly, built steadily, and left the biggest winners of the year down the most," Wilson said.
His observations are based on the broader view that the stock market is in a rolling bear market this year — a tougher environment to make money in.
"Perhaps the best way to express our rolling bear market view may be to simply overweight value vs growth as we are currently recommending in our sector weights," Wilson said.
Morgan Stanley is overweight utilities, energy, industrials, and financials.
Wilson added that while this recommendation may mean ditching the popular momentum stocks that have led the market higher, it's worth it at this stage. He noted that the outperformance gap between large-cap growth and value stocks was at its widest since the dot-com bubble. This gap isn't "justified" by forward growth and earnings expectations, he added.