Goldman Sachs, Morgan Stanley, and Bank of America say stocks are staring down a period of dismal returns with the recovery priced in. Here are the 9 areas of the market where they see the best opportunities.

  • As stock indexes sit near all-time-highs, Wall Street’s biggest banks say future returns look dim.
  • Strategists at Goldman Sachs, Morgan Stanley, and BofA aren’t bullish on the index in the near-term.
  • They share 9 areas of the markets where investors can find the best opportunities right now.
  • See more stories on Insider’s business page.

Stocks continue to reach new highs as the economy begins to reopen with more than 40% of the US population vaccinated against COVID-19.

But investors shouldn’t expect to continue seeing the returns they have over the last year, some of the biggest investment banks on Wall Street are now saying.

According to strategists at Goldman Sachs, Morgan Stanley, and Bank of America, the S&P 500 is staring down a period of weak returns with the economic recovery already largely priced in. 

In recent notes to clients, each firm highlighted reasons why they’re relatively bearish — or at least agnostic — on the performance of the broader market in the months ahead. 

Goldman Sachs on Monday pointed to the precedent of stocks’ performance when economic growth begins to slow, as their economists argue it will begin to do in Q3. They looked at historical returns of the S&P 500 based on readings of the ISM Manufacturing Index, an indicator of economic activity.

“Equities often struggle in the short term when a strong rate of economic growth first begins to slow,” Goldman’s Chief US Equity Strategist David Kostin said in the note. “During the last 40 years, investors buying the S&P 500 when the ISM Manufacturing index registered above 60 — typically coinciding with peak growth — have experienced a median return of -1% during the subsequent month and a paltry +3% return during the subsequent year.”

He continued: “The most recent ISM reading was 64.7. In fact, our S&P 500 year-end target reflects a 4% total return from the current level, including dividends. Our mid-year 2021 target remains 4100.”

These trends are laid out in the chart below.

Bank of America, meanwhile, said earlier this month that they expect the S&P 500 to end the year about 9% lower than current levels despite the fact that their economists are bullish on GDP growth for the rest of this year. 

Savita Subramanian, the head of US equity and quantitative strategy, cited five reasons for their negative outlook: exuberance in investor sentiment, high valuations, historically high returns as of late, an overshoot in fair value, and investors’ elevated risk appetite.

Their investor sentiment measure, shown below, was one point away from hitting “sell” levels.

In terms of valuation, current levels indicate that investors should expect just 2% returns per year over the next decade. They added that this can be said with a higher degree of confidence because current valuations can account for 80% of the explanation of how stocks do over the following decade. 

Finally, Morgan Stanley’s equity strategists have been advising clients that stock picking will be the best way to find returns going forward, instead of investing more broadly. Their price target for the S&P 500 remains 3,900, almost 7% lower than current levels.

This is because of risks involved with the reopening, like supply shortages for smaller businesses, and because of overextended valuations in some areas of the market — namely stay-at-home beneficiaries — the bank has said.

“We first began highlighting these concerns over a month ago and are now even more convinced those concerns are warranted,” Morgan Stanley’s Chief US Equity Strategist Mike Wilson said in a Monday note. “On valuation, the risk is elevated too.”

Where to find the best stock-market opportunities 

Given their concern around supply shortages, Morgan Stanley is recommending investors look to higher-quality stocks.

From a sector perspective, they like energy, financials, healthcare, capital goods, materials, and internet firms

Contrary to Morgan Stanley, Bank of America likes small cap firms as a play on the economic recovery. They also like cyclical stocks generally, as well as value stocks.

Goldman is also bullish on cyclical and value stocks with growth expected to stay strong into next year, but they also like cyclical stocks that are more global-facing because the economic recovery is playing out more slowly outside of the US. 

Rising bond yields should also help cyclicals, the bank said.

“Our rates strategists believe bond yields have near-term upside risk, which would also help extend the outperformance of recent cyclical sector and factor leaders and delay the likely market rotations until closer to mid-year,” Kostin said. “And once the rotations begin, the ongoing strength of economic growth should prevent the rotations from being as sharp as they often are when growth decelerates.”

There are dozens of exchange-traded funds where investors can gain exposure to the sectors listed above, such as the iShares MSCI USA Value Factor ETF.

But all three firms have also recommended stock picking. Below are examples of lists of stocks they’ve published recently where they think investors can find the best opportunities:

  • GOLDMAN SACHS: Buy these 45 ‘global-facing’ stocks set to benefit from the worldwide growth boom as the pace in the US begins to slow
  • Goldman Sachs names these 25 large-cap stocks as the most likely to deliver excess returns and crush the market as the stock-picking environment gets trickier
  • MORGAN STANLEY: Buy these 25 highly reliable stocks set to perform well in any market environment as rising prices threaten to crush profit margins

Get the latest Bank of America stock price here.

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