Bullish sentiment among Wall Street analysts is at a nearly two-decade high as equities markets continue to soar, according to Morgan Stanley data compiled by the Financial Times.
The data covers the largest 1,000 US-listed stocks and shows “buy” ratings at levels not seen since 2002, when US law was amended to crack down on conflicts of interest for securities analysts.
Passage of the 2002 Sarbanes-Oxley Act required analysts to disclose potential conflicts of interest and gave the SEC more latitude to go after conflicted analysts. Before the law, investment bank analysts often were incentivized to issue positive ratings for companies whose stocks their bank was underwriting.
In the post-2002 era, the percent of buy ratings floated south of 50%. After the financial crisis, that aggregate measure was slightly above 50%, according to the FT.
By contrast, buy signals now make up around 60% of all ratings.
The data come as markets continue to pierce new all-time highs, leading some to wonder whether US equities are overbought. In July, BlackRock, the world’s largest asset manager, downgraded US equities from overweight to neutral – pivoting instead to European stocks, which they saw as having much more room to grow.
However, US stock markets’ new highs have been underpinned by robust corporate profits. Firms listed by S&P are set to announce more than 60% year-on-year earnings growth in the second quarter, according to FactSet data cited by the FT.
As demand continues to outstrip supply, Morgan Stanley sees US businesses rushing to fill the breach with investment, boosting stocks in the construction and industrial sectors, analysts wrote in a note on Thursday.
Analysts described a “red hot capex cycle,” driven by supply constraints and sky-high demand, with investment growth exceeding GDP through the end of 2022. Looking at four decades of data, capex running above GDP has tended to predict robust sales in sectors that build physical structures – like construction, engineering, and industrial conglomerates – they wrote.
But in those sectors, the association between strong capex and stock market performance is less straightforward, in part because cyclical increases in capex can be short-lived.
So to capitalize on booming investment, the bank pointed to three underlying trends that are likely to sustain capex in a more durable way: “near-shoring” supply chains closer to home, automation and digitization, and decarbonization.
Stocks that are in a position to gain from these long-term developments are the best bets for the capex surge. In particular, analysts named Rockwell Automation and Eaton Corp, two industrial equipment companies, as strong buys.
On Rockwell, which sells industrial automation tech, analysts argued that automation tends to far exceed industrial production growth during hot capex periods and that markets are underestimating the business. Eaton, a electrical equipment manufacturer, is set to benefit from a wave of electrical equipment installation as firms invest in capital.
Year-to-date, Rockwell and Eaton are up 17% and 28%, respectively.
The odds of a stock market correction of up to 15% are rising as lofty technology stock valuations leave the broader market vulnerable, according to Morgan Stanley Wealth Management’s chief investment officer.
In a Monday note, Lisa Shalett highlighted how low rates have helped prop up tech stocks to dot-com era valuations. The price to sales ratio of the technology sector is at a level not seen since the peak of the dot-com bubble in 2000, she said.
In addition, the tech sector now makes up a much larger weight in the S&P 500 than in 2000, and has subsequently driven the price to sales ratio of the benchmark index to a level 50% higher than it has ever been.
“The problem with this setup is that tech sector profitability and earnings are vulnerable,” said Shalett. “While secular growth trends may support resilience against small changes in economic growth, the sector now faces unprecedented headwinds from rising input costs, a weaker US dollar, fiercer competition, higher taxes, stricter regulations and customer backlash.”
If those headwinds come to fruition for the technology sector, the broader market will be at risk.
She noted that markets tend to be strongest when they are broad based and there is a consensus narrative around what could go wrong in terms of economic outcomes, policy, geopolitics, and regulation.
“As we have noted for the past two months, the market continues to grind to all-time highs on narrowing breadth, while the narrative has also grown increasingly muddled. Thus, the risks of a correction are rising,” she said.
The chief investment officer of wealth management told clients to focus on stock-picking using earnings fundamentals. She also said investors could consider adding to financials stocks as a value-oriented hedge to rising rates.
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.
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.
Where some industries were able to quickly shift to telework and retain most employees through the pandemic, others are struggling to rehire. Job openings sit at a record-high 9.3 million, but hiring lagged economist forecasts for two months straight while quits reached all-time highs.
Several businesses have already raised wages in a bid to attract more workers than the competition. Yet certain sectors are still likely to see additional pay hikes as the shortage lingers, Morgan Stanley economists led by Ellen Zentner said in a Monday note.
“Wage pressures to-date have been relatively narrow, but our leading indicators point to labor market tightness in an increasing number of industries, raising the prospect of further wage increases and broadening out of wage pressures,” the team said.
Hotels, restaurants, and leisure businesses came out on top, with real estate management and development following close behind. Commercial services and supplies businesses touted the third-highest wage-risk score. Morgan Stanley homed in on which sectors are most likely to raise wages first by analyzing companies’ earnings-per-employee, estimated margins, and historic wage growth.
The sectors at the greatest risk of wage hikes shared a handful of characteristics. Many were among those hit hardest by the pandemic and related lockdowns. The top 10 sectors mostly consisted of service jobs, likely due to the mass layoffs seen in 2020. Retail businesses also face higher wage risk as consumer demand booms and businesses struggle with supply bottlenecks.
On the other end of the spectrum, producers make up most of the sectors with the softest wage risk. Independent power and renewable electricity businesses sit at the bottom of the list, followed by the oil gas and consumable fuel sector. Water utilities, tobacco, and telecom services businesses were all nearly tied for having the third-lowest wage risk.
Morgan Stanley also expects a larger share of sectors to drive wages higher. While 64% of industries saw above-trend pay growth since March, that share grew to 93% in April and reached 79% in May. A deeper look at industry-specific data shows wage pressures growing in middle- and high-wage industries, marking a departure from trends seen just before the pandemic, the team said.
Still, the elevated rate of wage growth might not be felt in the near term. Most industries’ pay hikes have been dwarfed by stronger inflation through spring. Only 21% of sectors saw pay climb faster than the Consumer Price Index in the three months through May, Morgan Stanley said. For workers to actually benefit from the faster-than-average pay growth, businesses will need to keep raising wages after the anticipated cooling of inflation.
Moderna shares fell sharply for a second session Thursday after the US said on Wednesday it supports waiving intellectual property protections for COVID-19 vaccines. The stock has now declined as much as 23% since Monday’s close after a 7% drop on Tuesday.
But Morgan Stanley said it doesn’t see a waiver materially hurting the biotech company’s business.
The Biden administration supports a waiver “in service of ending this pandemic,” even as it “believes strongly in intellectual property protections,” US Trade Representative Katherine Tai said in a statement Wednesday.
A waiver would allow other countries to make vaccines from Johnson & Johnson, Pfizer, and Moderna without fearing sanctions at the World Trade Organization.
While the US’s waiver support generates “a negative headline, we believe the practical impact is limited,” on Moderna’s business, said Matthew Harrison, an equity analyst at Morgan Stanley, in a note published Thursday.
He said Moderna’s management had previously indicated it wouldn’t enforce its intellectual property patent during the pandemic. Meanwhile, the investment bank said it doesn’t believe the WTO has any mechanism to force Moderna’s management to teach other manufacturers how to make its vaccine, which suggests no change in the status quo.
“Finally, we believe any new manufacturing operation could take 6-9 months to scale, effectively limiting the impact of other manufacturers,” wrote Harrison.
Shares of Pfizer were off by nearly 3% on Thursday and BioNTech was down by more than 2%.
“You have this political pressure to share patents with every pharmaceutical company. Then you have the other side of it, which is these pharmaceutical companies need to be motivated to always do research and development. Even though there was a pandemic and a humanitarian crisis, there is still a cost,” Hilary Kramer, chief investment officer at Kramer Capital Research, told Insider.
“Whether it’s Pfizer or Moderna or BioNTech, they have a responsibility to their shareholders and they also have a responsibility to continue to have a pipeline of products and to know [that R&D] is going to pay off,” she said. “We need to watch that – that could have a greater impact on pharmaceutical stocks.”
With the US economy on track for a summer rebound thanks to steady vaccine rollout and the landmark stimulus aid package, uncertainty about where investors should park their money abounds, Morgan Stanley said in a note Wednesday.
“Exiting the Covid-economy comes with significant uncertainties, and ‘reopening’ does not mean a full return to pre-Covid consumptions,” analysts led by Adam Virgadamo, CFA, said in a note.
With global equities near all-time highs after being pummeled by a year of the global pandemic, Morgan Stanley said it now sees a cyclical upside in three sectors: banks, capital goods, and materials.
The analysts developed a tool that uses a framework to analyze stocks in the US, Europe, and Japan. The process found that certain cyclical stocks which have large overlaps with reopening plays have “rerated relative to the broader market such that a recovery seems reasonably well priced.”
Europe: Banks and Capital Goods
Japan: Autos, Goods, Transports, and Materials
US: A more diversified mix though leaning toward Energy, Banks, Capital Goods, Airlines, a mix of Tech
Morgan Stanley said that much of the reopening is priced in, although not equally across cyclical sectors. Discretionary and industrials, for instance, are aggressively pricing recovery and reopening while energy, financials, and materials have been slower to do so.
The cycle reset, the bank added, also lowered the premium on defensive stocks, with health care among the most defensive for stock opportunities. Pockets of real estate, such as offices, meanwhile continue to face challenges.
Morgan Stanley said the cement and steel, clean energy, and healthcare sectors will be the top three beneficiaries of the historic cash infusion.
This isn’t the first time the investment bank has recommended a group of stocks based on the recent rise in infrastructure spending.
In an early April note to clients, Michael Wilson, Morgan Stanley’s Chief Investment Officer, said he believes “investors should consider a mix of traditional cyclicals and new beneficiaries that will gain from the combination of strong economic growth, as well as federal initiatives to bring US infrastructure into the 21st century.”
The extension of key green energy tax credits coupled with potential new tax credits from Biden’s spending plan are set to buoy the clean energy sector moving forward, according to Morgan Stanley.
The president’s plan also contains over $170 billion for electric vehicle technology, which Morgan Stanley says will help to bolster the sector despite high valuations.
In a note to clients on April 9, Wedbush’s Dan Ives echoed similar sentiments to the investment bank, saying that he believes Biden’s plan will bring about a “green title wave” for electric vehicles.
“The lifting of the 200k EV tax credit ceiling (restored to Tesla and GM) and a likely $10k+ EV tax rebate will be a major catalyst for EV growth in the US,” Ives said.
Cement and Steel
Morgan Stanley also highlighted the obvious beneficiaries of the infrastructure spending, cement and steel companies.
With $1 trillion set to be spent on transportation, water, and affordable housing, analysts at Morgan Stanley believe we are headed for an “infrastructure supercycle.”
The investment bank said over 200 million tons of cement will be used due to the infrastructure spending alone.
However, some market commentators question how much of the spending package has already been priced in.
When asked about which sectors may benefit from infrastructure spending, Burton Hollifield, a professor of finance at Carnegie Mellon University, told Insider that he believes much of the infrastructure spending bill has already been priced into equities.
Stock prices in the sector appear to back up Hollifield’s belief. Shares of US Concrete have already jumped 62% in 2021, and US Steel has followed suit, with shares rising 33% year-to-date.
Finally, Morgan Stanley analysts said they believe the healthcare sector will get a boost from President Biden’s new “human infrastructure” spending.
These “human infrastructure” measures include the expansion of affordable care act subsidies and a possible lowering of the medicare age.
Morgan Stanley says these changes would be a “fundamental positive for larger healthcare providers” as there will be more healthcare business to do overall, and larger healthcare companies would have the “scale to engage profitably.”
Bill Hwang built up a fortune of around $20 billion through savvy investments, but then lost it all in 2 days in March as his Archegos investment fund imploded after some of his bets went awry, a report has said.
Hwang, an alumnus of famed hedge fund Tiger Management, took around $200 million in 2013 and turned it into a $20 billion net worth by betting successfully on technology stocks, Bloomberg said in the most detailed look at Archegos’ finances yet.
But it all came crashing down at the end of March when some of Hwang’s highly leveraged bets started to go wrong and his banks sold huge chunks of his investments. The sales knocked around $35 billion off the value of various US media and Chinese tech firms in a day.
Bloomberg reported that Hwang’s early investments through his Archegos Capital Management family office included Amazon, travel-booking company Expedia, LinkedIn and Netflix, the latter of which reaped a $1 billion payday. Bloomberg cited people familiar with Hwang’s investments.
Hwang’s bets at some point shifted towards a broader range of firms, in particular media conglomerates ViacomCBS and Discovery. He also loaded up on Chinese tech companies such as Baidu and GSX Techedu.
Archegos’ investments powered it to a strong final quarter of 2020, with many of the stocks it held jumping more than 30%.
But the ViacomCBS bet would become particularly problematic for Hwang. It started to tumble during the week starting March 22, causing Archegos’ prime brokers – the major banks who lent it money and processed its trades – to demand more money as collateral, known in the business as a margin call.
With Hwang unable to put up the cash, Morgan Stanley sold around $5 billion of Archegos’ holdings at a discount, according to Bloomberg. Goldman then followed suit, selling billions of dollars of companies’ stock.
Some banks weren’t so fast, however, with Credit Suisse and Nomura left nursing estimated losses of $4.7 billion and $2 billion respectively.
A key reason that Hwang’s wealth collapsed so spectacularly is that he used large amounts of leverage. That is, Archegos borrowed lots of money to fund his investments, meaning it faced large losses when they went bad.
Gerard Cassidy, US bank analyst at RBC Capital Markets, told Insider in March: “Leverage is always a two-edged sword. In a bull market when prices are rising it enhances your returns. And then in a falling market, like you just saw in this particular case, it cuts your head off.”
Archegos was unavailable for comment but spokesperson Karen Kessler told Reuters at the end of March: “This is a challenging time for the family office of Archegos Capital Management, our partners and employees.”
“All plans are being discussed as Mr. Hwang and the team determine the best path forward,” she said.
Among the companies that stand at an advantage ahead of President Joe Biden’s massive infrastructure bill is Tesla, according to Morgan Stanley analysts, and owning the stock they say may be a bigger risk than not.
Biden’s $2 trillion infrastructure proposal carved out $174 billion for the electric vehicle sector alone, as the president aims to better equip American companies to compete with China, which is currently the market leader in the electric vehicle space.
Analysts at Morgan Stanley led by Adam Jones said in a note published Wednesday that Biden’s bill will increase Tesla’s advantage over legacy players and new entrants altogether.
The policy used to accelerate sales of electric vehicles will slow sales of internal combustion engine cars, the analysts said.
The analysts did warn that the build-out may follow a volatile and non-linear path.
“It will likely be complicated by a labyrinth of national and local laws that will present advantages and disadvantages to various automakers, depending on the year that you choose to analyze,” they said. “Put it all together and we believe auto investors face greater risk not owning Tesla shares in their portfolio than owning Tesla shares.”