(Bloomberg) — Bond markets and the S&P 500 are too sanguine about the economic outlook, according to Morgan Stanley’s chief U.S. equity strategist.
“We have another example of extreme divergence between the internals of the stock market which are strongly indicating a growth scare, while bonds and the S&P 500 are suggesting growth is not only ok, but likely to remain robust in the case of bonds,” Michael Wilson and his team wrote in a note to clients on Monday. This deviation will prove unsustainable, and cyclical stocks are the most vulnerable when it’s eventually resolved, they said.
U.S. stocks started the year on the wrong footing amid concerns that the Federal Reserve will have to tighten its policy more aggressively than previously anticipated as it seeks to regain control over runaway inflation. Wilson, who has been one of Wall Street’s most vocal bears, argues that this drawdown has yet to price a looming sharp slowdown of the economy.
“The internals of the equity market are telling a much different story than bonds or the headline S&P 500 index which continues to trade at valuations we find hard to justify,” according to the Morgan Stanley strategists. Defensive stocks, and in particular the utilities sector, are having one of their best absolute and relative periods of performance on record, Wilson said.
Central banks typically pause and reverse interest-rate hikes when the economy slows or goes into recession. While the outperformance of defensive stocks points to such a disappointment on the growth front, this is not currently reflected in bond markets or the broader equity market, Wilson said.
“We listen intently to what the internals of the stock market are saying because we believe it is the best strategist in the world,” he said. “Stay defensively oriented because growth is going to disappoint.”
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