Morgan Stanley
Wealth Management

How to Weather the U.S. Stock Selloff

Nov 1, 2023

Tightening financial conditions, persistent inflation and a mixed earnings outlook could make for more stock-market turbulence. Here’s how investors can prepare.

Author
Lisa Shalett
Lisa Shalett

Key Takeaways

  • Benchmark U.S. stock indices dropped sharply last week as investors appeared to confront new economic concerns. 
  • Financial conditions are tightening, just as surging GDP growth pressures the Fed to keep interest rates higher for longer.
  • Mixed corporate-earnings results and cautionary commentary by key companies further cloud the outlook for investors.
  • Value-oriented opportunities are emerging among financials, U.S. small- and mid-cap stocks, and international stocks.

What caused last week’s stock market correction?

 

Rising interest rates. Hawkish Federal Reserve rhetoric. A stall-out in progress on reducing inflation. Geopolitical conflict.

 

Any one of these developments might typically be enough to knock the U.S. equity market off course, but for much of this year, stocks rallied as investors appeared to shrug them off.

 

However, it seems the equity market has finally started to re-assess the investing environment. The S&P 500 Index fell 2.5% this past week, bringing the index down 10% from its recent high in July. The Nasdaq fell 2.6% last week and is off 12% from July. Both benchmark indices finished the week in a “correction,” defined as a fall of at least 10% from a recent high.

 

So, what has changed? We believe stock investors finally awoke to at least three realities:

  1. 1
    Financial conditions have finally begun to tighten.

    Conditions eased for most of last year despite rising interest rates, but it appears that a recent confluence of circumstances—U.S. dollar strength, resurgent oil prices, a slowdown in lending and widening credit spreads—has finally begun to drain market liquidity. For equity investors, this can mean fewer buyers in the market and a resulting decrease in demand for stocks. Tighter financial conditions also tend to be a drag on economic growth, which tends to weigh on corporate earnings. The Goldman Sachs financial-conditions index has tightened by about 2% since mid-July, drawing almost a perfect inverse correlation to the decline in the Nasdaq. 

  2. 2
    The economy remains strong.

    New data show that U.S. gross domestic product (GDP) had its strongest quarter since 2021, growing at a blistering 4.9% annual rate in the third quarter (adjusted seasonally and for inflation). On its face, this strength was a testament to consumer resilience and labor-market strength, but it also means that 18 months of Fed rate hikes haven’t quite put the intended chill on the economy. That suggests the Fed may have to hold rates higher for longer, given the risks of persistent inflation—which, by the way, accelerated in September. Meanwhile, the momentum in consumer spending may not last, as household savings run down and spending outpaces income growth. Both high interest rates and decreased consumer spending dim the outlook for stocks.

  3. 3
    Ambitious earnings expectations may be tested.

    Wall Street analysts and investors have been projecting strong company earnings growth in 2024 and 2025, but that outlook is worsening. As the third-quarter earnings season plays out, a mixed set of forward guidance and cautionary commentary by key companies may be reminding investors that the current backdrop of robust GDP growth is not sustainable and could set the bar uncomfortably high for results in 2024.

Looking Ahead

The way we see it, the stock-and-bond selloff in January–October 2022 marked Phase I of the current bear market. While some investors viewed the equity-market rally in October 2022–July 2023 as a new bull market, we see it as a mere retracement, or Phase II, of a continuing bear market. And today, we believe we are seeing Phase III, a period of potential volatility for both stock valuations and corporate profitability, in which stock indices remain rangebound. In this environment, short-term traders may find tactical opportunities, but long-term investors should stay patient and maintain a strategic outlook.

 

Consider using current market volatility to execute tax management strategies and rebalance portfolios toward investments that offer yields. Investors may also look at stocks with quality cash flows that are fairly priced based on achievable earnings targets. Value-oriented opportunities are emerging among financials, U.S. small- and mid-cap stocks, and international equities.

 

This article is based on Lisa Shalett’s Global Investment Committee Weekly report from October 30, 2023, “Bear Market, Phase III.” Ask your Morgan Stanley Financial Advisor for a copy. Listen to the audiocast based on this report.

Find a Financial Advisor, Branch and Private Wealth Advisor near you. 

Check the background of Our Firm and Investment Professionals on FINRA's Broker/Check.

Wealth Management Investors Eye Risks as U.S. Debt Surges Swelling federal debt could spell trouble for markets and the economy. How can investors prepare?
Wealth Management Will Investor Optimism Hit a Fed Wall? Investors may need to reevaluate three key assumptions driving confidence for lower rates from the Fed.
Wealth Management Why Higher Interest Rates May Not Go Away Why interest rates and economic growth could surprise to the upside and how investors can prepare.
Wealth Management DIY Investors: Why Choose a Morgan Stanley Financial Advisor Why DIY investors have confidence in the investing decisions they make together with a Morgan Stanley Financial Advisor. Get the facts.
Investors Eye Risks as U.S. Debt Surges
Wealth Management Investors Eye Risks as U.S. Debt Surges
Will Investor Optimism Hit a Fed Wall?
Wealth Management Will Investor Optimism Hit a Fed Wall?
Why Higher Interest Rates May Not Go Away
Wealth Management Why Higher Interest Rates May Not Go Away
DIY Investors: Why Choose a Morgan Stanley Financial Advisor
Wealth Management DIY Investors: Why Choose a Morgan Stanley Financial Advisor

More Insights

Discover more insights for your portfolio from Morgan Stanley. 

Wealth Management Portfolio Insights Thoughts on the Market

Index Definitions

S&P 500 Index: The Standard & Poor's (S&P) 500 Index tracks the performance of 500 widely held, large-capitalization US stocks.

Risk Considerations

Equity securities may fluctuate in response to news on companies, industries, market conditions and general economic environment.

The value of fixed income securities will fluctuate and, upon a sale, may be worth more or less than their original cost or maturity value. Bonds are subject to interest rate risk, call risk, reinvestment risk, liquidity risk, and credit risk of the issuer.

High yield bonds (bonds rated below investment grade) may have speculative characteristics and present significant risks beyond those of other securities, including greater credit risk, price volatility, and limited liquidity in the secondary market. High yield bonds should comprise only a limited portion of a balanced portfolio.

Companies paying dividends can reduce or cut payouts at any time.

Asset allocation and diversification do not assure a profit or protect against loss in declining financial markets.

Investing in small- to medium-sized companies entails special risks, such as limited product lines, markets and financial resources, and greater volatility than securities of larger, more established companies.

Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies. Technology stocks may be especially volatile. Risks applicable to companies in the energy and natural resources sectors include commodity pricing risk, supply and demand risk, depletion risk and exploration risk. Health care sector stocks are subject to government regulation, as well as government approval of products and services, which can significantly impact price and availability, and which can also be significantly affected by rapid obsolescence and patent expirations.

The indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment.

The indices selected by Morgan Stanley Wealth Management to measure performance are representative of broad asset classes.  Morgan Stanley Wealth Management retains the right to change representative indices at any time.

Disclosures

Morgan Stanley Wealth Management is the trade name of Morgan Stanley Smith Barney LLC, a registered broker-dealer in the United States. This material has been prepared for informational purposes only and is not an offer to buy or sell or a solicitation of any offer to buy or sell any security or other financial instrument or to participate in any trading strategy.  Past performance is not necessarily a guide to future performance.

Morgan Stanley Smith Barney LLC, its affiliates and Morgan Stanley Financial Advisors do not provide legal or tax advice.  Each client should always consult his/her personal tax and/or legal advisor for information concerning his/her individual situation and to learn about any potential tax or other implications that may result from acting on a particular recommendation.

This material, or any portion thereof, may not be reprinted, sold or redistributed without the written consent of Morgan Stanley Smith Barney LLC.

© 2023 Morgan Stanley Smith Barney LLC, Member SIPC.

CRC#6058226   (11/2023)

View Disclosures Close Disclosures