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Morgan Stanley equity strategist Adam S. Parker reports that investors are asking 4 big questions, to which he provides his thoughts.1) Is this just a temporary soft patch? While US GDP will likely recover in the second half of 2011, the correlation between GDP and the S&P 500 is negative year-to-date and very low historically. Moreover, auto stocks are not responding to the prospect of a 2H production recovery, with F and GM now at multi-month lows. In our view, even a mid-cycle correction (the current bull case) is likely to last longer than just a few weeks. We are not buyers of the retreat, at least until forward profit margin expectations get reset, as market sentiment has shifted –it’s now guilty until proven innocent.
2) What about energy stocks? While Brent has now strengthened back to within just 5.4% of its 2011 high, the stocks have nonetheless declined 5% month-to-date. We remain neutral on energy stocks, preferring low beta exposure until evidence that strengthening demand resurfaces.
3) Are banks cheap enough? The correlation of the net income between banks and retailers is high, and pair-trading banks against retailers is now likely prudent giving the compelling attractiveness of banks’ beta. We remain market-weight financials, however, due to concerns about demand for loans and regulatory risk.
4) Where’s the attractive beta? Technology and industrials have been highly correlated in recent weeks, with AAPL, GOOG, MSFT, CAT, GE, DE, and UPS, among others, at or near multi-month lows. Technology has never been cheaper on price-to-forward earnings relative to industrials, and we remain overweight technology and underweight industrials.
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