Time to get defensive in US stocks, interest rate hike may weigh on valuations; buy these sectors

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Stock market, Us Federal ReserveMorgan Stanley analysts believe that the primary reason for the resilience in the major US equity indices is the continued fall in longer-term interest rates.
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US stock markets are now bracing for the final stage of transition, emerging out of the covid-19 induced recession, according to Morgan Stanley’s Chief Investment Officer and Chief U.S. Equity Strategist, Mike Wilson. This phase is expected to see the US Federal Reserve take centre stage, tightening monetary policy and hiking interest rates, which would weigh on equity valuations. US Federal Reserve, earlier in June, had brought forward the time frame on when it will next hike interest rates. Meanwhile in India, the Reserve Bank of India (RBI) has time and again calmed investors, saying it will continue with the accommodative stance as long as necessary to revive and sustain growth on a durable basis.

Also Read: How to invest in Apple, Amazon, Google, other US stocks from India: All you need to know

Mike Wilson said that Morgan Stanley’s belief that the recovery from the covid-19 recession was much more advanced was confirmed by the National Bureau of Economic Research (NBER), which said that the COVID-19 recession was over in May of 2020 — or just two months after it started. “This is also why stock markets have rebounded to new all-time highs in record time, too. In short, everything is happening faster than normal during this recession and recovery,” the US equity strategist said.

Fed rate hike coming ahead

In the mid-cycle transition narrative, promoted by Morgan Stanley since March, the first three stages have already passed. These include the rate of change on economic and earnings growth peaking, equity markets narrowing with fewer stocks keeping up with the torrid pace of the initial recovery and third, leadership moving away from those sectors that do their best during the early stages of recovery. “The final part of the transition is still yet to come and may have a more meaningful impact on the major averages, which remain very resilient despite the deterioration in market breadth,” Mike Wilson said.

Morgan Stanley analysts believe that the primary reason for the resilience in the major US equity indices is the continued fall in longer-term interest rates. “This extremely low rate doesn’t exactly jibe with an economy that is growing close to 10% year over year. And the reason is crystal clear – a Federal Reserve that is moving more slowly than normal at this stage of the recovery,” they added. This slow movement of the US Fed is not sustainable, according to the brokerage firm. “… the Fed itself knows the longer it waits to start, the faster it’ll have to go later, and that could lead to financial instability, or even threaten the economic recovery,” Morgan Stanley equity strategist said.

Time to go defensive

To tide over the expected change in US Fed’s stance, Mike Wilson said that Morgan Stanely continues to recommend investors take a more conservative approach and favour defensive sectors like healthcare and consumer staples while using financials as a hedge against higher rates later this year as the Fed begins its tightening process.

In India, the RBI’s MPC has begun its three-day deliberations today. Most expect the monetary policy committee to maintain its accommodative stance. “Given the fragile nature of recovery and uncertain outlook, we expect the MPC to maintain status quo on rates,” said brokerage and research firm ICICI Securities. MPC is expected to continue prioritising supporting growth over checking inflation.

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