Falling inflation and rate cuts may be bad for stocks, says Morgan Stanley's Mike Wilson
Contrary to popular perception, falling inflation and interest rate cuts won't necessarily be good for stocks, according to Morgan Stanley's Chief U.S. Equity Strategist Mike Wilson. As soon as the U.S. Federal Reserve starts cutting rates, there's this "presumption" that there's going to be this big movement into equities, said Wilson on Wednesday, speaking at the Morgan Stanley Asia-Pacific Summit 2023 in Singapore. "I would argue the exact opposite," he said. He explains why: The moment it's clear that the Fed is done raising rates, there's going to be "an incredible movement of money into bonds," he said. This would be against a backdrop of investors already being underweight on bonds. "Rate cutting cycles are not necessarily good for equities," he said. And falling inflation is bad for stocks because rising prices are what drives earnings, he explained. "One of the things that I think is different about today's setup … is that … the average equity (not the FAANG stocks) are now positively correlated to the rate of change of inflation," he said. He was referring to the Big Tech stocks of Meta (formerly known as Facebook), Amazon, Apple, Netflix, and Alphabet (formerly known as Google). "Whenever inflation is falling like it is today, it's typically not good for the average stock because it's not good for earnings growth," Wilson explained. The bad news is that "it's pretty clear" that inflation is falling, he said. "Supply chains are easing again, in a dramatic way that we've never seen. Supply chains this loose, and what that means to me is there's a lot of product out there — there was a ton of inventory started when we calculated — and order books now are really slowing down because companies are saying well we don't really need any more product, we got plenty," Wilson said. When inventories are too high, companies just don't have the pricing power, he explained. "So now that inflation is coming down, and they start cutting, just be careful what that means for stocks. Historically speaking, the evidence is here. It's not typically good for stocks and this could be a big head fake next year," he concluded. How to invest Overall, with markets in a late-cycle environment, one investing strategy right now would be a barbell of defensive growth and late-cycle cyclicals, said Wilson. A barbell strategy is to have a balance between reward and risk by investing in the two extreme ends of high-risk and low-risk assets. The current environment is historically a supportive backdrop for traditional defensive sectors such as health care, consumer staples and utilities, as well as late-cycle cyclicals such as industrials and energy, said Morgan Stanley in a separate report released this week. It named stock picks it rated overweight in these categories: Health care and biotech: UnitedHealth , Biogen, Abbvie. Consumer staples: Walmart , Costco. Utilities: DTE Energy, Exelon Corporation. Energy: ConocoPhillips, Marathon Oil, Valero Energy