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  • US stocks may fall under pressure this year as stocks rerate, Morgan Stanley CIO Mike Wilson wrote.
  • Defensive signals like falling bond yields are typical of a mid-cycle market.
  • Morgan Stanley has 19 high-quality defensive stocks to buy that offer growth at a reasonable price.
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Major US stock market indexes are still vulnerable amid a “rolling correction” that’s been in place since February, despite what’s been another year of strong returns and fresh highs for stocks.

That’s according to Mike Wilson, Morgan Stanley’s chief investment officer and chief US equity strategist, who wrote in a July 12 note that recent market moves reflect a “mid-cycle transition” where market breadth narrows, meaning the number of outperforming stocks shrinks. 

The S&P 500 has steadily climbed in 2021 and passed Wilson’s year-end target of 4,225 on the back of strong earnings and record levels of fiscal stimulus in a reopening economy, though some stocks and sectors have corrected by over 20%. 

But markets are quietly getting defensive, as is typical in the mid-cycle, Wilson wrote. A sudden rush to bonds, which has depressed US Treasury Note yields, reflects an appetite for safety as investors worry that catalysts from the first half of the year, such as stimulus payments and a broad economic reopening, are losing steam.

“Asset prices most levered to these drivers are now under-performing broadly, suggesting there may not be as much pent-up demand as the consensus now is modeling,” Wilson wrote. “Instead, we think there could be a payback as the stimulus fades and year-over-year growth in personal disposable income decelerates and turns negative next year.”

Wilson expects stocks to slide by year’s end in a 20% “de-rating” process where the market’s forward P/E recedes from today’s 21.3x earnings to 18x earnings. Wilson wrote that stocks have only de-rated approximately 5% so far this year.

“We have taken a different view than the consensus citing the potential for a slowdown in the second half of the year due to monetary aggregates’ growth decelerating and peak rate of change on economic and earnings revisions,” Wilson wrote.

A slowdown in growth doesn’t need to sink an investor’s portfolio, however. Larger companies, especially “high-quality” stocks that are financially healthy with reliable profits, usually outperform in this environment, Wilson wrote. He also favors defensive stocks, which often top the market when growth slows. By contrast, small-cap stocks tend to decline when the economy cools.

Here are 19 high-quality, defensive stocks rated overweight (buy) by Morgan Stanley for growth at a reasonable price, along with each company’s ticker, sector, industry and market cap.