• Thoughts On The Market
  • September 3, 2021

So, What’s the Story?

Transcript

Welcome to Thoughts on the Market. I'm Mike Wilson, Chief Investment Officer and Chief US Equity Strategist for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about the latest trends in the financial marketplace. It's Monday, August 23rd at 11:30 a.m. in New York. So let's get after it.

There is an old adage that says, "never bet against the US consumer's willingness to spend". In fact, it was one of the primary reasons we led the charge on recommending consumer cyclicals back in April of 2020 - at the depths of the covid recession. With Congress quickly providing record amounts of fiscal stimulus last year, the table was set for a major consumer stand against the downturn. Fast forward 16 months, and it's fair to say the U.S. consumer has not disappointed. However, after a year of remarkable resilience from the U.S. consumer, it begs the question, is it sustainable? While there's little doubt about the US consumer's willingness to spend, the other key variable to consider is their ability to spend.

After riding one of the best periods of outperformance for consumer discretionary stocks in history, we downgraded the sector back in April of this year, given our view for an eventual payback in the consumption we experienced during the pandemic. The reasons were twofold: first, from our analysis, it appears as if there wasn't much of a recession at all when looking at real personal consumption, which is currently 15% above its long-term trend. Second, as the stimulus runs off this quarter, it's very likely consumption will return to trend and maybe even fall below it for a short period of time.

With the writing on the wall with respect to the potential payback in consumption, we were surprised to see many shrug off the decline in the University of Michigan consumer confidence two weeks ago. In fact, even with our less constructive view on consumption, we were a bit surprised by just how dramatic of a fall the survey produced. The headline plunged to new cycle lows - below the levels witnessed during the worst of the recession last year. If that weren't enough to convince folks of the downside risk for consumption, a week later, disappointing July retail sales numbers were released. The combination of the two keeps us in the camp that consumption is likely to get worse before it stabilizes and keeps us underway consumer discretionary stocks.

Related to this view is our cautious call on semiconductors. While most people know semiconductors are a big input for personal computers, cell phones and other electronic goods, they also go into washing machines, refrigerators, autos as well as other consumer and industrial goods. If we're right that consumption is about to take a break, it's likely that semiconductor demand will turn out to be unsustainable and undergo a cyclical correction. Our analysts recently downgraded memory chip companies on a similar peak of cycle view, and we think it could be much broader than just DRAM.

In contrast, we've upgraded Utilities and Consumer Staples sectors as a good place to be as demand trends soften this fall. Both groups have been outperforming nicely, along with other defensive sectors like healthcare, which we also favor. In addition to consumer discretionary, other cyclical areas like Energy and Materials have also been under pressure as derivative plays on the reopening of the economy, which looks to be challenged by the Delta variant. While that is another concern for the economy, we're more focused on the cyclical peak analysis, which is arriving with or without Delta.

Bottom line, stick to a large cap quality bias within your equity portfolios with a more defensive tilt until slower demand trends are more accurately reflected in forecasts, valuations or both.

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Although a key component of investing is getting the narrative correct, perhaps a bigger component is knowing when the narrative could change.

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