MS says risk-reward in U.S. equities remains unattractive, sees 15-20% downside risk

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By Senad Karaahmetovic

Morgan Stanley analysts weighed in on the discussion that the ongoing banking crisis and back-stopping of bank deposits represent a form of quantitative easing (QE). As such, equity markets will rally in a risk-on environment.

“We disagree with that conclusion and think the focus should be on the more likely deterioration in growth due to the incrementally restrictive lending/credit environment that is now upon us,” they told clients in a regular weekly column.

The analysts also oppose the idea that mega-cap tech offers shelter from excessive volatility. Instead, investors should turn to defensive, low-beta sectors and stocks, they added.

Morgan Stanley's analysts also urged investors to continue focusing on the fundamentals. Moreover, they added that the breadth is deteriorating.

“On this front, we flag the material relative underperformance of the S&P 500 Equal Weighted Index vs. the Cap Weighted Index. Further, the cumulative advance/decline series for the Nasdaq Composite Index has fallen significantly over the past several weeks, diverging from price. Ultimately, these are signs of unhealthy market internals, in our view,” the analysts said.

“Just to remind readers, the S&P 500 ERP is currently 230bp. Given the risk to the earnings outlook, risk/reward in US equities remains unattractive until the ERP is at least 350-400bp, in our view. Assuming 10-year UST yields can fall a bit further as markets begin to worry about growth more than inflation, that translates into a P/E multiple of 14-15x, 15-20% below the current multiple,” they concluded.