The stock market has been navigating uncertain waters, as experts debate the possibility of a recession and its potential impact on stock prices. Mike Wilson, Chief Investment Officer and Chief U.S. Equity Strategist at Morgan Stanley, has consistently remained in the bears’ camp in this debate. However, this year has surprised him, as the S&P 500 rallied despite rising interest rates and inflation.
Recently, the market has faced some challenges, with the blue-chip index falling 6% since July. For Wilson, this is a clear sign that the market is stuck in a “purgatory” state as investors await the outcome of the Federal Reserve’s aggressive interest rate hikes.
Wilson explains that during these late-cycle environments, when the Fed is nearing the end of consistent interest rate increases, there tends to be a high level of uncertainty that leads investors to take a more cautious approach. However, after several premature recession calls in 2022, investors may have become overly optimistic at the start of this year, resulting in an overpriced “soft landing” narrative.
The chief strategist is concerned that we may exit this market purgatory and enter into a recession. He believes middle- to lower-income consumers have depleted the excess savings they built up during the pandemic, while student loan repayments are restarting. This could lead to a slowdown in spending, significantly impacting the 70% of U.S. GDP that is driven by consumer spending.
Given these concerns, Wilson suggests that investors adopt a defensive approach and avoid jumping back into high-flying growth-focused stocks for the time being. Instead, he recommends seeking quality, large-cap stocks with robust balance sheets and earnings. These companies are less likely to borrow money to operate their businesses during periods of high interest rates.
In uncertain times, Wilson and his team believe that quality dividend-paying stocks can be good options for investors. They have historically outperformed non-dividend paying stocks, particularly when inflation is high but falling. Dividends provide a positive return cushion and tend to outperform during market volatility.
To select dividend stocks, Wilson and his team recommend a holistic approach that considers valuations relative to peers, historical volatility during challenging times, and overall leverage. They have provided a list of top dividend picks with a three to five-year outlook, including Verizon Communications, Realty Income (a real estate investment trust), Exxon Mobil, and more.
Overall, while the market remains in a state of uncertainty, investors should consider a defensive approach and focus on quality dividend-paying stocks to weather potential storms. By being mindful of balance sheets, earnings, and volatility, they can position themselves for success in a challenging market environment.