High volatility on cards in US stocks in 2nd year of bull run; these sectors may offer good returns

US stock market benchmark indices S&P 500 and the tech-heavy Nasdaq Composite posted double-digit returns in the calendar year 2020, resembling trends of 2009, the first year of emergence from a deep recession. Andrew Slimmon, Head of Applied Equity Advisors Team, Morgan Stanley Investment Management, said that while past performance does not necessarily predict future results, being an active equity investor does require understanding historical moves. Slimmon added that when the rally began last year and volatility dropped, the bull market climbed significantly higher before bears took over late in the year.

Amid hopes that COVID-19 pandemic might soon be behind us with distribution of vaccines, Slimmon believes that investors may find it tougher to generate stock market returns similar to last year. The returns in the second year of a bull market are historically positive, Morgan Stanley said in its blog, adding that stocks this year may deliver 2010-like performance, year two of the bull market that started in 2009. The S&P 500 index surged 68 per cent from March 2020-low until the end of the year. Now, stocks are likely to take a breather, much as they did in the second quarter of 2010.

Morgan Stanley sounds caution

Morgan Stanley sees high stock market volatility in the calendar year 2021, which may impact who recently put their cash to work in equities. Based on history, it advised investors to hold tight and keep eyes on the longer term. “The second year of a new bull market historically performs quite well overall, though it tends to be more gut-wrenching along the way,” it added. The S&P 500’s current P/E ratio is high relative to its historical value. In the previous year the S&P 500 index rallied over 15 per cent. Morgan Stanley said that apart from the tech bubble of the 1990s, in the last 44 years, such a high price multiple has never been sustained.

Where can investors look for returns?

Companies whose valuations were at low relative to their history, ie, value stocks; for example, banks, movie theaters and cruise lines, were impacted the most by the effects of the pandemic-induced recession. Historically, the best time to own value stocks has been when the economy is exiting a recession. Morgan Stanley highlighted that as a group, these value stocks began recovery in 2020; but in 2021, these stocks are still cheaper relative to historical levels. “In our current economic recovery, we see opportunity in value stocks, focusing on those companies with strong balance sheets,” it said.

While outside of the US, Slimmon focuses on Asia ex-Japan technology stocks. This group historically benefits from US dollar depreciation, and technology stocks in this part of the world are trading at significantly lower valuations than their US peers. “We see both compelling opportunities in the stock market and the potential for a solid year of returns, as would be consistent with the second year of a bull market in equities, but we do expect significantly more volatility along the way,” Morgan Stanley said.