Morgan Stanley strategist who called the October pullback says it's time to buy

Published Mon, Nov 2 20209:08 AM ESTUpdated Mon, Nov 2 202011:18 AM EST

(This story is for CNBC Pro subscribers only.) Morgan Stanley — which called the market pullback in October — is now urging investors to buy equities again. "Bottom line, it's time to start adding risk again, but selectively," Morgan Stanley chief U.S. equity strategist Mike Wilson told clients on Monday. Heading into the new month, the Wall Street firm told clients to buy stocks set to see the biggest jump in their earnings outlook next year as the economy recovers. Morgan Stanley said the driver of the next leg in the bull market will be earnings, not valuations. The S & P 500 is down nearly 9% from its most recent high, suffering in October from a lack of fiscal stimulus and amid a rise in Covid-19 cases in the U.S. and abroad. Morgan Stanley called the correction last month , saying investors were "too complacent on the uncertainty surrounding the election outcome, unlikely passage of a fiscal stimulus before the election and second wave of Covid-19." Wilson added: "The worst of the correction is over in our view but we still think the next month is likely to remain volatile and uncertain as we navigate what is shaping up to be a much closer election than expected just a few weeks ago and risk of further lockdowns as the virus runs its course." Wilson said the equity risk premium now has a larger buffer built in, given the upcoming risks. However, it could take some time for the S & P 500 to resume its bull trend "in earnest," he said. "We recommend buying stocks that are likely to have the greatest positive revisions to 2021 earnings estimates." In an earlier note , Morgan Stanley pointed to this companies as having the biggest improving earnings picture: JPMorgan , Regions Financial , Harley-Davidson and Mosaic . "We think cyclical parts of the market that have seen smaller revisions to next year's numbers will have stronger relative earnings revisions breadth," said Wilson. "On the other hand, Tech names and work from home beneficiaries, which already have seen expectations raised, will likely struggle to see their numbers go even higher." Morgan Stanley expects the 10-year Treasury yield to rise significantly, even as much as a 100 basis point move. Wilson said a sharp move in yields is likely to have a negative impact on S & P 500 price-to-earnings ratios initially because the equity risk premium won't fall fast enough to fully offset such a rise in rates." "This adjustment should be greatest for those companies with the highest multiples (very expensive growth stocks) and those companies whose earnings are most negatively correlated to higher rates (defensives). Conversely, the damage should be least on lower P/E companies and those that benefit from higher rates (financials and cyclicals)," Wilson said. "In short, add to stocks this week but keep a bias toward those stocks that are more fairly priced should a big rate rise occur as we expect," Wilson added. Morgan Stanley also likes Ross Stores , Yum China , Five Below and Ally Financial for strong earnings revisions next year. — with reporting from CNBC's Michael Bloom.

The Charging Bull near Wall Street is pictured in New York.

Carlo Allegri | Reuters

(This story is for CNBC Pro subscribers only.)

Morgan Stanley — which called the market pullback in October — is now urging investors to buy equities again.

"Bottom line, it's time to start adding risk again, but selectively," Morgan Stanley chief U.S. equity strategist Mike Wilson told clients on Monday.

Heading into the new month, the Wall Street firm told clients to buy stocks set to see the biggest jump in their earnings outlook next year as the economy recovers. Morgan Stanley said the driver of the next leg in the bull market will be earnings, not valuations.