Over recent weeks, investors have experienced a flurry of conflicting economic signals, creating violent whipsaw activity in the markets. On a particular day, there may be a release of pivotal economic data that indicates a steady Fed, prompting markets to sell off. Then, subsequent releases of other significant data may lead markets to expect that the Fed could quickly lower rates. This has created unnerving market volatility, with bullish investors swiftly changing course and opting to sell within days or weeks.
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Investors should be interested to know that Morgan Stanley (NYSE:MS) strategists think that they have a solution to calm the queasy stomachs of both FOMO (Fear of missing out) investors and FOBI (Fear of being in) investors. In a recently released analyst’s note, Morgan Stanley Strategists, led by chief U.S. equity strategist Mike Wilson, discussed the mixed signals of the economic data. The strategists recognize the economy is giving off confusing signals, and suggest investors start playing defense. They also provide advice on how to do this.
Mixed Signals and Market Swings
A recent example of this economic data confusion is the contrast between the April jobs report and the inflation figures released shortly beforehand. The jobs report indicated a cooling labor market, leading some traders to speculate that the Federal Reserve could potentially cut interest rates as early as this summer.
However, the earlier inflation data showed that prices were accelerating. This caused stock market weakness, as it suggested the Fed would indeed keep rates higher for longer. The Fed’s main mandates are to maximize employment and maintain price stability.
These reports, each pointing in different directions, provide opposite-pointing signs for the mandates and the markets.
Morgan Stanley’s Take
Given this uncertainty, Mike Wilson believes investors should consider a more cautious approach. Wilson defines the cautious approach as playing defense. He says that with the economy giving off mixed signals, investors should look at consumer behavior with an eye towards defensiveness.
The Morgan Stanley strategist likes a subsector of the consumer goods market that focuses on what he calls “high-end stability.” Wilson said consumption is split between “high-end stability and lower-end weakness.” He finds that companies are working to offer value “as the lower income cohort pulls back and trades down.” In simpler terms, households with limited resources are cutting back on non-essential spending but continuing to purchase essential items. Therefore, companies selling these essentials have greater flexibility to raise prices. Conversely, consumer goods that are considered more optional do not possess the same ability to increase prices.
Consumer discretionary companies like Nike (NYSE:NKE), Amazon (NASDAQ:AMZN), and Netflix (NASDAQ:NFLX) are more at risk because customers can readily pull back on their products or services. This isn’t the case for consumer staples like laundry detergent.
Wilson said, “We see consumer staples as a beneficiary of trade down from discretionary categories.” There is evidence of this trend emerging, reflected in earnings revisions for consumer staples versus consumer discretionary. Wilson noted that earnings revisions for consumer staples have recently improved, “pointing to upside in relative performance from here.”
The SPDR Consumer Staples Select Sector ETF (NYSE:XLP) is used here as an indicator of the sector’s performance. This core sector tends to perform well even during economic downturns because consumers still need essential goods like food and beverages. The top four holdings in this indexed ETF are Procter & Gamble (NYSE:PG), Coca-Cola (NYSE:KO), PepsiCo (NYSE:PEP), and Walmart (NYSE:WMT).
Key Takeaway
Mixed economic data can create a volatile stock market. While the overall market outlook remains uncertain, Morgan Stanley suggests that investors consider adding defensive sectors like consumer staples to their portfolios as a hedge against potential downturns, especially in the lead-up to key economic data releases.
