Morgan Stanley Is Looking For Estimate Achievability, Advises Portfolio Strategy

Concern About Sustainability

HUDSON: Lost in the headlines this week was corporate earnings. Second quarter earnings season is tapering off now. Profits show a double- digit increase yet again. Earnings per share are up more than 18 percent from a year ago, marking the seventh straight quarter of double-digit growth. Seven out of 10 companies that have reported have turned in better than expected results so far. Our “Market Monitor” tonight is Adam Parker, chief U.S. equity strategist at Morgan Stanley (NASDAQ: NBXH) (NYSE: MS). Adam, welcome to NIGHTLY BUSINESS REPORT. Do you think investors have ignored these earnings with all the other noise coming out of the markets and in Washington this week?

ADAM PARKER, CHIEF US EQUITY STRATEGIST, MORGAN STANLEY: Investors have paid attention to them but there`s been less upside this quarter than the previous. You`re right, the estimates have come in better than expected, but the guidance was probably a little bit worse than expected. Some specific industries, like industrials, which are considered a proxy for the economy and the economic health were a little bit light. So I would say it`s a bit of a mixed bag, more than just an unbridled positive if you really look at earnings season.

HUDSON: Is the market disconnected from earnings season because of all of the concerns about the weak economy or do you think it actually is connected considering the less-than-stellar outlook that we`re seeing from some of the most sensitive sectors?

PARKER: I think it really is connected. There`s really two things you have to consider when you think about the stock market. One is the earnings, which you just alluded to. And the other is that multiple, the price-to-earnings or how much you`re going to pay for the earnings and our differentiated call at Morgan Stanley (NASDAQ: NBXH) (NYSE: MS) this year has been on that multiple. We think you`re going to pay less for the earnings because you`re going to be concerned about the sustainability. You`re going to be concerned about some of these macro issues you alluded to.

HUDSON: To that point, your sense of the earnings growth, that 18 percent we`ve seen so far in this quarter not sustainable here in the second half of the year?

PARKER: We don`t think so. Our view has been from the beginning of the year that the estimates in the first half of the year were achievable, but in the second half of this year or in 2012, we think the estimates that the analysts have in there are just too optimistic, particularly for profit margins. If you look under the hood here at the earnings season, one thing that`s quite interesting is that the rewards for beating have been far smaller than the penalty for missing and that`s a key to thinking about how we`re going to set up in the second half of the year.

HUDSON: That`s certainly the setup for a portfolio strategy. Adam, stick around. We`ll get to your investment ideas a little bit later on in this program.

PARKER: OK, great.

Portfolio Strategy

TOM HUDSON: With corporate earnings still exhibiting a healthy growth rate, but coming under pressure here in the second half of the year, our “Market Monitor” is playing defense. Adam Parker, chief U.S. equity strategist at Morgan Stanley (NASDAQ: NBXH) (NYSE: MS), back with us. Adam, if you’re playing the fence, what makes a defensive strategy for investment in this kind of climate with this volatility?

PARKER: It really is relative estimate achievability. You want to own stocks in sectors where the estimates are more achievable, where they have less downside should the economy slow. So we’re recommending areas like health care, utilities and energy, where we think the estimates are more achievable in the second half of the year than the broader market. We’re recommending investors avoid or underweight sectors like consumer discretionary and industrials where the estimates, in our mind, accelerate too much and are therefore unachievable.

HUDSON: You’re looking for areas that do have kind of a lower hurdle so that they can get over. You mentioned health care. Let’s pull this one out. We’re using exchange-traded funds as proxies for the sector. It clearly has come off its most recent highs — the entire market has this week — but this has been very good performance over the past year. What do you think fueled this higher outside of the expectations?

PARKER: In January this year, when we went overweight health care, I thought it was very contrarian. The idea was that the estimates were more achievable, the valuation was compelling. Most professional investors had heard of things like the generics cliff and health care reform and these companies had a lot of cash on the balance sheet to deploy in a productive direction. I still think that’s true despite the fact it’s probably a little less contrarian in its work. I still think the estimates are more achievable in the second half of the year and that should be a relative safe haven in this more risk-averse environment we’re now in.

HUDSON: You mentioned utilities as well, a classic defense posture there and certainly the dividend yield is a big attraction. What do you make of the utilities space and the concern about lower demand if the economy continues to soften?

PARKER: I think you nailed it up front there, which is, if you’re constructing a portfolio, you really have to be mindful of the beta or the risk in that portfolio. Utilities stocks are generally lower beta, generally higher yielding and the analysts there generally have a very good view of what the earnings outlook looks like. If I’m worried, which I am, that the estimates are too high in the broader market, I probably have a better understanding. I’m a little bit safer with the estimates in utilities so again, it’s that relative estimate achievability that makes that sector attractive right now.

HUDSON: Managing expectations, no doubt about it. Do you own any of the ETFs that we used as proxies for your sector ideas?

PARKER: Of course not.

HUDSON: It is our Friday “Market Monitor” from New York, Adam Parker. Thanks Adam, chief U.S. equity strategist at Morgan Stanley (NASDAQ: NBXH) (NYSE: MS).

PARKER: Thanks a lot.

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