Mike Wilson of Morgan Stanley: The other recent change in capital markets weighing on secular growth stocks is the newfound discipline on profitability. In my last Sunday Start, I discussed the impact We Company’s failed IPO would have on investors’ willingness to fund unprofitable businesses. This has played out in lower valuations for the worst offenders. I’ve noticed that several of these companies have reported higher-than-expected profitability during 3Q earnings season. I think this represents an effort to avoid the new scrutiny. But higher profits in the short term likely mean less spending and therefore lower growth in the intermediate term, leaving investors in these hyper-growth companies to figure out the right valuation.
The bottom line is that the winds of change are upon us and the long-overdue adjustment process for the most expensive secular growth stocks is under way and will likely continue until valuations become so cheap that they discount a more achievable outcome on growth and profitability and/or the risk of economic recession and lower capex subsides. I don’t think we’re there yet on either score, so we continue to recommend a more defensively oriented equity portfolio in the US with overweights in Consumer Staples and Utilities, while remaining underweight Technology and Consumer Discretionary. We’re also overweight Financials, because at some point either recession risk will abate or we’ll want to look through the recession once it’s inevitable and the consensus view. Finally, given the aggressive stance of central bankers around the world, the yield curve should re-steepen over the next year, no matter what the outcome, supporting bank earnings and stocks. In short, we favor value over growth, but with a defensive rather than cyclical skew on the value side.