Analysts at Morgan Stanley do not see the rally lasting. In a note on Monday they said they expect earnings growth to peak and benchmark 10-year Treasury yields to move lower, resulting in an eventual inversion of the so-called yield curve where short-dated interest rates climb above longer-dated interest rates.
“We’ve been highlighting all year our view that 2018 would mark an important transition year resulting in an aggressive rotation toward defensive sectors at some point,” they said. “That point has arrived and suggests the broader US equity indices could be at risk, too.”
Indeed, defensive sectors like consumer staples and real estate led gains for the S&P 500 in June, while technology, financials and industrials all posted losses.
Morgan Stanley is also advising clients to be wary of the rally in US small-caps. The Russell 2000, up 10.6 per cent for the year to date, has been supported by fears of rising trade disputes, with investors perceiving small caps to be sheltered from the storm due to these companies being more domestically focused.
“We are also becoming concerned that small caps may be getting too much of a tailwind from the rising trade tensions,” wrote the analysts. “As investors worry about escalation of trade issues, money has left large multi-nationals in favor of domestically oriented small caps. While this makes sense intuitively, we doubt small caps will be immune from a hit to economic growth if trade tensions escalate into significant trade disputes.”