Trade tensions and the 2020 presidential election will add even more uncertainty to the aging U.S. economic recovery, making surefire defensive stocks and consumer staples more attractive investments, according to Morgan Stanley.
Chief U.S. equity strategist Michael Wilson told clients in a note Monday that expectations of "disappointing" S&P earnings next year should allow companies like Coca-Cola, Lowe's and McDonald's to outperform the broader market.
"Trade, the election, and a late cycle economy keep the market searching for new leadership amid high uncertainty," Wilson wrote.
"We expect the market to vacillate between a pro-cyclical outcome and a defensive one as data comes in and trade tensions and the election evolve," he added. "We slightly favor the more defensive outcome given our well below consensus forecast for S&P 500 earnings growth next year."
The investment bank sees GDP growth in the U.S. stabilizing below trend under 2% for the next year and labor costs accelerating, both of which are set to pose headwinds in the new year.
Wilson also reiterated his 2020 S&P 500 target of 3,000, which implies that the major market index will fall 4.5% over the next 13 months. The projection makes Morgan Stanley one of the two most-bearish brokerages tracked by CNBC: The median S&P 500 strategist target for year-end 2020 is 3,325, 5.9% above Friday's close.
UBS is the only other firm with a target as low as 3,000.
Wilson said his lackluster forecast for U.S. equities comes despite easier monetary policy and hopes that trade relations between Washington and Beijing are improving.
In fact, Wilson wrote that central bank liquidity and positive seasonal data could boost the S&P 500 to overshoot the upper end of his 2020 bull case. But by April, he wrote, the liquidity tailwind should fade and the market will refocus on company fundamentals.
"Uncertainty means rotations should continue and their durability will depend on whether growth is accelerating or decelerating," Wilson wrote. "With the S&P 500 currently above the upper end of the channel due primarily to excessive central bank balance sheet expansion, we think risk reward skews lower, and would prefer to be more opportunistic when adding risk."
Others on Wall Street worried
Wilson's concerns echo growing worries by stock pickers that equities may be overpriced in general following November's string of record highs.
RBC's Lori Calvasina, for example, warned last week that Wall Street's biggest money managers are the most upbeat on stocks than they've been in months, a sign that investors should expect a market top in the months ahead.
"Positioning in the US equity market among institutional investors has turned euphoric and highlights the extent to which FOMO (fear of missing out) has gripped the institutional equity investor community," she wrote.
Investment advisors looking ahead to 2020 have stressed a portfolio that prioritizes low debt and consistent income. Nearly all strategists with 2020 outlooks highlighted the importance of finding under-loved stocks with solid fundamentals as opposed to the high-flying growth stocks that carried the market for much of the last decade.
Wilson recommends that investors look at names like Coca-Cola and McDonald's, both of which promise better-than-average earnings potential and free cash flow.
Coke is Morgan Stanley's top pick in the U.S. beverage space thanks to what the firm's analyst described as "clearly superior topline growth vs. large cap CPG peers, driven by stronger pricing power, strategy changes, ramping innovation, and momentum in emerging markets, which we believe is not reflected in its current valuation." Wilson excerpted the Coke analyst's comments in his report.
The investment bank sees shares of Coke rising 12.3% to $60 per share over the next year.
— CNBC's Michael Bloom contributed reporting.