There's an unbalanced economy of have and have-nots. Here's how investors should approach that, says Morgan Stanley.

MW There's an unbalanced economy of have and have-nots. Here's how investors should approach that, says Morgan Stanley.

By Steve Goldstein

The latest consumer sentiment survey, released Friday, fell in June to a seven-month low. But the details of the report are even worse than the headline suggests.

Morgan Stanley's stock-market strategists led by Mike Wilson say what's important is to look at the spread between the measure of current conditions and expectations.

"The speed and magnitude of the decline is notable with this spread making all-time lows going back to the early 1980s. This is hard to dismiss as an errant data point, in our view, and it lines up with our persistent call that the health of the economy and consumer is not nearly as strong as the headline GDP data has suggested," say Wilson and team.

"Instead, we believe we are dealing with an unbalanced economy of 'haves' and 'have nots.'"

The cause is simple enough - while inflation may be receding, price levels are not, and that's led consumer expectations of real income gains over the next five years to tumble.

The Morgan Stanley team says the same dynamic is playing out in the stock market, where breadth has been narrow and where small caps, and the equal-weighted index, are underperforming.

The S&P 500 SPX has gained 14% this year, vs. a 3% rise for the S&P 500 equal-weight index XX:SP500EW, and a 2% decline for the Russell 2000 RUT.

"Bottom line, we don't see a reason why this narrowing of leadership and quality bias will change in the near term as we remain in a late cycle economy where strong fiscal policy is helping to still keep interest rates too high for many economic participants-a dynamic confirmed by the inverted yield curve," they say. "In short, the policy mix is crowding out most businesses and consumers and this phenomenon is now reaching a point where it can influence the aggregate data unless policy changes significantly."

That said, policy may change soon - Morgan Stanley expects Fed rate cuts to begin in September, after last week's surprisingly tame consumer and producer price data.

   Performance after the first Fed rate cut 
   Previous 9M  Previous 6M  Previous 3M  Next 1M  Next 3M  Next 6M  Next 9M  Next 12M 
   Small Cap Value                           0.90%        1.90%        1.60%        -2.00%   -1.40%   -2.30%   -4.80%   -3.80% 
   Small Cap Growth                          -3.90%       -4.90%       -2.90%       -0.90%   -1.60%   -3.00%   -2.10%   1.10% 
   Large Cap Value                           4.00%        4.60%        3.70%        -0.80%   0.80%    0.50%    -0.20%   -3.00% 
   Large Cap Growth                          3.10%        1.70%        1.10%        0.60%    0.90%    2.70%    4.00%    6.70% 
   Source: Compustat/Morgan Stanley 

They say what works when the Fed starts cutting is large-cap growth. "We think this has to do with the notion that the Fed is often cutting rates later in the cycle as nominal growth slows. This is typically a time when the market pays up for large cap quality and secular growth properties," say Wilson and his colleagues.

Those kind of companies feature in what Morgan Stanley calls its fresh money buy list - featuring CenterPoint Energy $(CNP)$, Coca-Cola $(KO)$, Colgate-Palmolive $(CL)$, McDonald's $(MCD)$, Mondelez International $(MDLZ)$, SBA Communications $(SBAC)$, Verizon Communications $(VZ)$ and Walmart (VZ).

-Steve Goldstein

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June 17, 2024 04:00 ET (08:00 GMT)

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