- Morgan Stanley’s US equity chief Mike Wilson thinks the economy’s reopening will be faster than many expect, and says he has received pushback for this view.
- His bullish outlook leads him to recommend buying cyclical stocks that historically do best in the early stages of recoveries.
- Wilson recommends details two areas of the stock market ideal for playing the recovery.
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Mike Wilson is not loathe to hold contrarian viewpoints on the stock market.
Last year, the chief US equity strategist at Morgan Stanley was among the most bearish among his peers at major firms. He even suggested in October that a recession was needed to flush lofty expectations for the economy.
Little did anyone know that he was speaking at the tail ends of the longest bull market and economic expansion in history.
Wilson is running against the wind once again — this time in a direction that is bullish for the economy and stock market. He expects that the economy’s recovery from its worst recession in a century will be faster than many expect, and is strongly recommending that investors buy cyclical stocks to profit from the upswing.
“We’ve been more optimistic than most on the ability of the economy to reopen despite the virus, and over the last few months this is the part of our view that received the most push back,” he said in a recent note.
In a year that has surprised investors at every turn, Wilson is urging investors to be ready for more plot twists ahead.
The backbone of his bullish thesis is the amount of monetary and fiscal stimulus that has been poured into the economy since the recession arrived in February. These emergency policies — including zero interest rates and stimulus checks to millions of Americans — have already aided the recovery process and revived animal spirits in markets
While their impacts are undeniable, there remains the question of whether a second wave of virus infections will grind the economy to a halt again. Wilson’s clients also mentioned to him that because the pandemic was like a natural disaster, the economy is likely to return to the low-growth and low-rate environments that characterized the previous expansion.
On these crucial points, Wilson counters that the economy has actually started a brand new, durable cycle that sheds its characteristics of the past. And in this scenario, the historical evidence piles up in favor of buying cyclical stocks now.
Morgan Stanley
“Our work shows pretty conclusively that cyclicals outperform when inflation, personal income, and GDP growth are accelerating and while PMIs, consumer sentiment, and rates are rising,” Wilson said.
With Wilson’s expectations in mind, here are the 2 trades he recommends to profit from the cyclical upswing in the second half of the year:
1. Financial stocks
The conventional wisdom is that low interest rates depress banks’ earnings. If the Fed expects zero interest rates through 2022, why bet on financials now?
Wilson’s contrarian answer is that rates will rise faster than the market expects as economic growth rebounds strongly next year. “Rising yields, steepening curves, low valuations, light positioning, and the stimulus mitigating the credit cycle are all positives,” he added.
Citizens Financial Group and S&P Global are the two financials on Morgan Stanley’s list of stocks it recommends investors buy in the near term.
2. Small-cap stocks
Companies worth between $300 million and $2 billion generally lead returns coming out of recessions. And Wilson expects their earnings to recover faster than large caps this time, which would help them outperform.
He noted that their price-to-earnings ratios are relatively higher than larger companies. However, this is because many companies have negative earnings, which makes their valuations appear higher relative to prices.
“On other metrics such as Price to Book or Price to sales, small caps are still considerably cheaper than the S&P 500 looking back over the last 5 years,” Wilson concluded.
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