Morgan Stanley stock strategists say accelerated Federal Reserve tightening is the real danger for equities, not the omicron Covid strain.
“A new COVID variant started the ruckus for markets, but we view that as secondary to the real culprit — the Fed's more aggressive response to the on-fire [economic] data,” wrote the strategists, led by Chief U.S. Equity Strategist Michael Wilson.
“Lower valuations is our call for 2022, and the Fed's accelerated taper just brings it forward. Favor large-cap defensive quality.”
Further, “the [stock-market] decline over the past few weeks still leaves P/Es higher than they were two month ago, with unfinished business on the downside due to the mid-cycle transition rather than omicron,” Wilson said.
“In that regard, Chair Powell's determined pivot to a faster taper was the key driver of the de-rating over the past 2 weeks, because tapering is tightening for asset prices, if not the economy.”
The forward S&P 500 price-earnings ratio stood at 20.4 Dec. 2, well above the five-year average of 18.4 and the 10-year average 16.6, according to FactSet.
“The vast majority (70%) of S&P 500 industry groups are currently trading in the top 25% of historical forward P/E levels going back to 2010 (even with last week's volatility),” Wilson said. “And all but five groups (out of 24) are trading above the S&P's average multiple since 2010 (15.9X).
“Bottom line: elevated valuation is pervasive, despite a lot of focus on a concentrated market. We think this strengthens the case for a market multiple de-rate and puts the focus on stock selection.”