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‘Who’ll Stop The Rain’? A Quick Look At One Bank’s ‘The Selling Has Just Begun’ Call

"We have been out on a limb the past month."

If you think “way” back to three weeks ago, Morgan Stanley “went there” … they downgraded tech from overweight to equal-weight.

Consensus aside, that seemed justified from a kind of common sense perspective. After all, according to BofAML’s monthly global fund manager survey, “Long FAANG” has been the most crowded trade on the planet for six months running (five at the time the Morgan call came out).

Optimism around the market darlings that together accounted for the lion’s share of the S&P’s first half gains had reached the point where USA Today was quite literally imploring life guards to plow their summer job money into FANG stocks because (and this is a quote), “investing in Facebook, Amazon, Google stocks could turn summer job pay into a fortune.”

That’s when you know they do indeed “ring a bell at the top”.

“We think the risk is rising that US tech and growth stocks will get wet”, Morgan Stanley said, in their July 9 note, before explaining as follows:

While we are not worried about an economic recession as the catalyst for underperformance in these market leaders like it was back in early 2016, we do think that 2Q earnings season will bring an inevitable acknowledgement from companies that trade tensions increase the risk to forward earnings estimates, even if managements don’t formally lower the bar.

Fast forward to this week and the FANG+ index fell into correction territory (see: “The Devolution Will Be Televised“).  Meanwhile, the long-awaited Growth-to-Value shift appears to be gaining some traction.

GrowthValue

This, Morgan Stanley says in a followup to the July call mentioned above, is just the beginning.

If that’s true, it’s about time (just ask David Einhorn). After all, the relative outperformance of Growth versus Value now borders on the ridiculous:

ValueVGrowth(Morgan Stanley)

“We have been out on a limb the past month with our defensive rotation call and truth be told, we haven’t had much interest from clients wanting to follow us down this path”, the bank wrote on Monday, in a testament to how reluctant giddy market participants were to accept the idea that abandoning the high-fliers ahead of earnings season made sense.

That assessment was actually a reference to the bank upgrading Utilities three week’s prior to the July tech downgrade, which the bank amusingly notes was “met with even less client interest.”

Needless to say, Morgan’s call looks pretty prescient now and one wonders what those reluctant clients are saying on Tuesday. The bank of course believes that misses from Netflix and Facebook support their thesis, but what’s particularly interesting is their documentation of how the broader market managed to digest things with remarkable alacrity last week, emboldened by the nebulous “deal” between Trump and Juncker. Here’s Morgan, recounting:

We must admit, the market sent some misleading signals over the last few weeks by limiting the damage to the broad indices when Netflix and Facebook missed. We believe this simply led to an even greater false sense of security in the market. The icing on the cake was perhaps the positive statements following the talks between Juncker and Trump which pushed the major indices past key resistance levels late in Wednesday’s session. The price action in that last half hour of trading Wednesday showed some evidence of potential “panic buying”and hedges getting stopped out. We can attest that we were having a difficult time ourselves as the S&P passed our upside target of 2830.

However, by Friday, the market appeared finally exhausted. With Amazon’s strong quarter out of the way, and a very strong 2Q GDP number on the tape, investors were finally faced with the proverbial question of “what do I have to look forward to now?” The selling started slowly, built steadily, and left the biggest winners of the year down the most. The bottom line for us is that we think the selling has just begun and this correction will be biggest since the one we experienced in February. However, it could very well have a greater negative impact on the average portfolio if it’s centered on Tech, Consumer Discretionary and small caps, as we expect.

Clearly, the bank is pretty pleased with how their call has panned out and they’re sticking with the defensive rotation thesis going forward.

You might remember that Morgan’s July 9 note downgrading tech contained the following allusion to bad weather:

Throw in the fact that these stocks have rarely, if ever, been so over-loved and over-owned, and the risk of a proper rain storm in this zip code increases significantly.

Well folks, the storm hit this week for tech. Now, the only question is: “Who’ll stop the rain”?

 

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1 comment on “‘Who’ll Stop The Rain’? A Quick Look At One Bank’s ‘The Selling Has Just Begun’ Call

  1. Error404

    Good piece, and the logic is as close to irrefutable as anything gets in today’s market. Just two thoughts:

    It’s a tad Trump-like to see that miniscule dip in the growth-value chart as “traction”. Still, all reversals have to start somewhere. AAPL might have a thing or two to say about whether from here the wheels spin or the tread bites into the dirt.
    I’ll be curious to see what effect the heavy FANG+ weighting in instruments beloved of the passive crowd might have this time around if/when the ‘smart’ boys turn full-on defensive.

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