The S & P 500 looks ready to join the bear market, according to Morgan Stanley. Defensive stocks are the latest big outperformer as investors have sought safety from this year's volatility, the firm found. But now even these stocks have become expensive, making them a less appealing refuge, Morgan Stanley's equity strategist Michael Wilson said in a note Monday. It also suggests the broad market index will catch up to the average stock and enter a bear market, which Wilson defines as a drop of 20% from the recent high. On Monday, it was down about 11% for the year, and about 12% from its recent high. "Unfortunately, we now find ourselves at a bit of a loss for new ideas," Wilson said in the note, later highlighting large cap pharma and biotech as two of the few areas investors can turn to for defensive exposure at relatively attractive prices. "The market has been so picked over at this point, it's not clear where the next rotation lies," he added. "In our experience, when that happens, it usually means the overall index is about to fall sharply with almost all stocks falling in unison." Wilson said the "accelerative price action" at the end of last week, when the market reversed course for the week and all of the major averages plummeted more than 2% on Friday, is "indicative of what to expect next — lower beta/defensive stocks outperform but they still go down." Additionally, poor performance in materials and energy signals that growth will be the primary concern for stocks, rather than inflation, the Federal Reserve and interest rates, Wilson said. "We believe inflation and inflation expectations have likely peaked, and while others have been using this as a bullish argument, we would like to send a clear warning — be careful what you wish for," he wrote in the note. "Falling inflation comes with lower nominal GDP growth and therefore sales and EPS growth, too. For many companies it could be particularly painful if those declines in inflation are swift and sharp." Pharma and biotech Large cap pharma and biotech stocks historically outperform in the macro environment Morgan Stanley sees unfolding this year, Wilson said in a separate note. Gilead Sciences , Vertex , Regeneron , Pfizer , Merck and Eli Lilly are among the highlighted stocks that have healthy dividends and attractive valuations. "As the U.S. economy moves to a late-cycle phase and GDP/earnings growth rates decelerate for the overall economy and market, we think Pharma/Biotech's defensive properties will outweigh policy concern and drive relative performance higher," Wilson said.
A screen is seen on the trading floor at the New York Stock Exchange (NYSE) in Manhattan, New York City, U.S., March 7, 2022.
Andrew Kelly | Reuters
The S&P 500 looks ready to join the bear market, according to Morgan Stanley.