Morgan Stanley has decided that the time has come where they feel the need to cut back on their exposure to the stock market, and they are telling clients to do the same.
Morgan Stanley is becoming more concerned that the stock market may be reaching a top and their near-term outlook has dimmed. Morgan Stanley strategist Andrew Sheets has cut the firm’s global equities allocation from equal weight to underweight, meaning that they are now pulling back on stocks overall.
We need to realize that when Morgan Stanley makes these moves, their situation is quite different from the one that we face as individual investors, as institutions this large hold and deal in huge volumes, the kind that you have to be more forward thinking with. A good comparison would be between turning around a supertanker at sea, which requires a lot of time and space to reverse its course, versus a pleasure craft which can be turned around much more quickly and easily.
This all has to do with relative degrees of liquidity that are present in each situation. If we are holding a few hundred or a few thousand shares, you can place an order like this at the market and get a good fill provided that the stocks you trade in are liquid enough. You may not get the very best bid, because there may only be 100 shares at that price, but that’s for only those who are selling 100 shares.
However, the modestly sized orders that we place will find bids very close to this, and there really isn’t any need to do anything but sell at the bid for whatever number of shares that you are looking to sell. In a matter of mere seconds, you can be out of the trade, and you can liquidate your entire stock portfolio this way if desired, all very quickly and easily.
Imagine that you were instead looking to move tens of thousands of shares of the same thing. You could just place an order like this at the market and you may be able to get filled that way, but at an average share price well below the current best bid. What you would want to do instead is sell your shares more gradually, watching the price move up and then unloading some there, and then waiting for more opportunities like this to take advantage of,
If the price of your stock is moving down, this can easily involve getting a worse price for your large lot than if you just dumped it all on the market, so this is both risky and tricky. If you are instead dealing with millions of shares, this task becomes even more difficult, and much more so in fact.
We Don’t Have to Anticipate the Market Like the Big Guys Do
With challenges like this, we can easily see how much more challenging it is for funds to get in and out of positions. While they can usually top off or redeem shares to process the orders that their clients make, moving all of this size to something else can be a real headache indeed and involve a lot of what is called slippage, the difference between the price something is at when you decide to buy it and sell it and what you end up paying or getting for the stock.
This is the main reason why index funds tend to beat actively managed funds, as with index funds, there is no changing horses, you just stick with the exact same ones that are in the index you are tracking. If you are tracking the Dow for instance, you are always holding all 30 stocks in the correct proportion.
This does not mean that there will not be slippage with index fund purchases and redemptions, but this is significantly minimized over active funds. Another constraint of active funds is that since it is so much trouble to switch stocks, this limits the number of moves that you can make quite strictly and also commits you to holding positions longer than may be desired in a lot of situations.
This is due to the overall trading costs involved, which for individual investors is minimal, and we therefore only need a small advantage to do this, an expected value that is greater than the cost of the trades along with a premium to account for whatever risk is involved.
Applying this to the current market situation, another way of putting this is that individual investors can much better afford to sit tight and wait for things to turn to the downside because when it does become time to get out, they can just do it very quickly and without having to worry about where we may be going from here and what will happen during the time it takes to exit our positions.
A big institution needs to prepare for events such as market reversals far more in advance then we do. If there is talk about a reversal, we may be able to wait, but if they wait too long, they may be spending their time exiting during a significant downturn.
We need to understand this so that when we read that an institution as large as Morgan Stanley with hundreds of billions of dollars in assets is looking to cut back on their holdings, we don’t just jump to the conclusion that if they are doing this, we should as well.
To give you an idea of the difference in size that we’re talking about, while we might own a few hundred shares of Amazon stock, Morgan Stanley currently holds over $8 billion worth of this stock alone, and if they are concerned about it, they can’t wait until this volatile stock tanks to do it.
They aren’t worried about the near term so much as they have the ability to ride out these moves of course, but if their view really does change, if for instance they see the risk of a significant fall in the stock’s price on the horizon, they may see fit to reduce their exposure to this.
This actually isn’t a bad strategy for individuals to use as well, to a lesser degree anyway, where it can be wise to cut back on our positions at various times, and add this back later when the seas are calmer. Being close to all-time highs, without anything particularly scary on the horizon, and not even being in the midst of a significant market pullback may be jumping the gun a little, for us anyway.
Is the Near-Term Outlook Really That Bleak?
We may even wonder if Morgan Stanley is jumping the gun as well right now, and there may be a tendency for managers to be a little quicker on the draw than may appear to be necessary, but these managers do need to look out for themselves, which involves the way they will be evaluated as well as any impact on bonuses that they may have earned.
This change in view does represent a downgrade of sorts for the market itself, and these are things that investors pay attention to and even act on at times, so the downgrade itself does weigh in on the future outlook of the market at least somewhat.
This is not unlike other downgrades though where the news hits and those bothered by it get out, and then we move forward without them. This in itself, together with whatever selling that Morgan Stanley does as a result of their change of view, really would not impact things very much and certainly nothing that should shake investors out.
Sheets believes that, in the battle now going on between the Fed looking to ease and the slowing economy, the slowing economy will win out as far as which wins the battle to influence stock prices the most.
He remarks that “we think a repeated lesson for stocks over the last 30 years has been that when easier policy collides with weaker growth, the latter usually matters more for returns. Easing has worked best when accompanied by improving data.”
The question that we need to ask here is whether looking back that far, 30 years, really should trump what is actually going on in 2019, where it is quite clear that potential easing by the Fed is winning out over any concerns about the economy slowing a bit.
There is no question that when we get easing and improving data together, that will end up driving stock prices up more than easing in the face of this data deteriorating a bit as it is now, but this does not mean that this won’t work well enough to keep things moving ahead right now.
The market is so focused on easing right now that even a small hint of it will spark a rally, and they will also sell off in the face of data showing that the economy is doing well, like it did during both last Friday and on Monday.
This is certainly representative of how this battle is playing out right now and the data side of things is clearly coming out the loser. If the next bit of news is negative for the economy, it would not be surprising to see a rally come out of it, and we’ve seen this before actually with Trump’s proposed Mexican tariffs, among other things.
While it is important to consider history, it never can trump the present, and the fact that the market may have cared more about economic data than easing at some point in the past does not mean much if this is not the case presently.
Sheets is also concerned about the upcoming earnings report, and believes that the market has not fully priced in the disappointment that will result from this. That’s quite possible and perhaps even likely, but we need to realize that this is just one factor that people use to decide and not even a particularly meaningful one to investors, who need a lot more than just a little disappointment sending us down a bit from all-time highs to want to get out.
The concern right now is how much the market has priced in a rate cut later this month, and if we don’t get a quarter point, and we may not, this can certainly cause a pullback, but once again, not one of the sort that people who need a lot to even want to cut back on their positions would care or should care much about.
It wouldn’t be a terrible idea for some investors to take a little off of the table right now, if this helps them sleep at night. Otherwise, we may just want to let the Fed handle any downturns in the economy that they see fit to act on, and at least wait until there comes a time when they are no longer able to keep the ship steady, which can happen but is not a place we are in yet.