Morgan Stanley: The stock market is at a ‘tipping point’ because of higher rates, dump growth names

The recent jump in interest rates may have created a tipping point for stocks where the decadelong investment theme favoring growth over value is changing, according to Morgan Stanley.

Mike Wilson, equity strategist at Morgan Stanley, said in a note that the rise in interest rates has signaled the possibility for end-of-cycle risks, which would cap stock market gains and lead to intramarket rotations.

“We think this creates a tipping point that explains many of the performance themes this week and lays the groundwork for something of a regime change that is very much in line with our overall outlook for the S&P 500, as well as our style and sector recommendations,” Wilson wrote in a note.

Wilson has previously said that he believes a multiyear bear market is already here and stock market gains will be limited with the S&P 500 trading in a range of 2,400 to 3,000 over the next several years.

“Yields are rising but growth will likely slow next year, which means portfolios need to shift,” he wrote in a note.

“It is worth noting that on Thursday last week, MSCI World Value Index had its best one day outperformance relative to World Growth since May 2009. This makes us think the market action last week is the beginning of a more sustainable move,” wrote Wilson, who is chief U.S. equity strategist and chief investment officer of Morgan Stanley Institutional Securities and Morgan Stanley Wealth Management. The Nasdaq was down 1.8 percent that day, led by declines in the high-flying FANG names, like Alphabet and Amazon.

Value outperformance

Wilson said he also sees more downside for small caps and high multiple growth cyclicals like technology and consumer discretionary. “With S&P 500 upside capped on a valuation basis, it’s more likely that Value outperforms by going down less or simply not going down,” he wrote.

Wilson said he now expects asset allocators to be forced to consider shifting out of growth to value, a call he made in July.

Wilson said besides a new low in unemployment, strong services ISM and hawkish comments from Federal Reserve Chairman Jerome Powell, yields may have risen last week on politics with the prospect of a Republican sweep in Congress. The markets have been expecting Democrats to regain the House and the GOP to hold a Senate majority.

“If the market begins to believe that a Republican sweep is likely to occur in the midterms, the likelihood of a tax cut extension, infrastructure spending and continued focus on trade protectionism all rise. We view these potential policy paths as inflationary and likely to add to the deficit, providing upward pressure on rates,” he wrote.

He said the difference between the Republican sweep that pushed rates higher in 2016 is that the policies the market was expecting then, like tax cuts and fiscal spending, came with an immediate fiscal boost to growth. That will not likely be the case after the midterm election, and the economy also has less slack at this point, he added.

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