Morgan Stanley is recommending a barbell strategy to play the market. Here’s what that means

Published Mon, Aug 30 20211:09 PM EDTUpdated Mon, Aug 30 20214:29 PM EDT

Jesse Pound @/in/jesse-pound @jesserpound

The stock market is trading at record highs as stimulus from Congress and the Federal Reserve appear to be reaching their end. Because of this, investors should hedge their portfolios with a "barbell "approach to protect against a pullback, according to Morgan Stanley. Morgan Stanley equity strategist Mike Wilson has warned investors that a pullback of 10% or more is coming, but he said Monday in a note to clients that the shape and leadership that correction could take is unclear. For Morgan Stanley, the market now faces a "fire or ice" scenario after a mid-cycle rotation has all but played out. This outlook calls for a barbell approach, which is a strategy that involves being overweight on two distinct groups of stocks to hedge against uncertainty about the market's next move. Wilson predicts the path of the economy will determine the winners and losers in the months ahead. "On one hand, we could see a continued strong economy and inflation drive the Fed to tighten policy, which would lead to higher interest rates and lower equity valuations. Here you want to own cyclicals and avoid expensive long-duration growth stocks," the note said. "In the other scenario, the payback in demand and weakening consumer confidence leads to a materially softer growth outcome than the consensus currently expects. Here, you want to own defensives." Creating a barbell portfolio means that the investors should add stocks in the potential winning areas while minimizing exposure to sectors that are deemed more risky. In this case, Morgan Stanley is cautious on high-growth tech names — which could get hit by rising interest rates — and consumer discretionary stocks — which would suffer in an economic slowdown. "Bottom line, this fall we still expect our mid-cycle transition to end with a 10%+ S & P 500 correction, but a narrative of either fire or ice will determine the leadership. As such, our recommendation is a barbell of defensive quality with financials to participate and protect in either scenario, which appear equally likely to occur, in our view." Defensive quality stocks, which often include health care and consumer staples names, would be expected to hold up well in a market downturn, while financial stocks should perform well if the economic expansion leads to higher interest rates, according to the firm. For investors looking for individual stocks, Synchrony Financial , food producer Mondelez International and health insurer Humana are on Morgan Stanley's "fresh money buy" list. -CNBC's Michael Bloom contributed to this report.

A weightlifter takes part in a training session during preparations for the 2016 Olympic Games to be held in Rio de Janeiro, Brazil

Luis Robayo | AFP | Getty Images