U.S. Stocks Enter the "Death Zone": What it Means for Investors

Dear readers,

This past week, a top Wall Street strategist, Mike Wilson, chief investment officer at Morgan Stanley, issued a warning that U.S. stocks have entered the “death zone.” In mountaineering, the term describes heights that humans can't live for long, where survival is dependent on speed or supplemental oxygen. Wilson uses the metaphor to describe the current market, which is liquidity-soaked and struggling to navigate through exceptionally low “equity risk premium.”

The equity risk premium (ERP) is a mathematical representation of something investors intuitively know: risky stocks should return more than safe bonds. However, the current ERP is abnormally low, and Morgan Stanley puts it at about 1.6 percentage points, versus double that for much of the past decade. This, combined with falling earnings estimates and rising Treasury yields, has sent stocks into the “death zone.”

Wilson predicts that the S&P 500 will end the year at 3900, but only after tumbling to a range of 3000 to 3300 during the first half. However, he advises investors not to panic and to favor defensive sectors like healthcare and consumer staples and efficient operators in industries like retail. Morgan Stanley even has a small Fresh Money Buy List, with names like Coca-Cola (KO), Exxon Mobil (XOM), and Verizon Communications (VZ).

For investors seeking income, UBS stock strategist Alastair Pinder notes that dividend stocks have tended to outperform during recessions and currently trade at a 15% to 20% discount to the market. He suggests looking for moderate yields with plenty of potential for payment growth, as well as quality signals like healthy returns on equity, resilient margins, and manageable debt. Their recent screen for such companies included Broadcom (AVGO), Amgen (AMGN), Procter & Gamble (PG), and Extra Space Storage (EXR).

Overall, it's essential to stay cautious in the current market environment and avoid unnecessary risks. Defensive sectors and quality dividend stocks can be good options for investors seeking stability and potential growth.