Morgan Stanley: Subsequent pressure will be greater! Reducing holdings in semiconductors, Chinese tech stocks still have attractiveness

Morgan Stanley pointed out in its stock strategy report released on April 7, Eastern Time, that "certain market indicators have shown significant pressure, but we are concerned that subsequent pressure may be greater... Continue to hold long-term bonds, short stocks, and hold defensive stocks..."

The S&P 500 index has fallen 17% since its peak in February, and the volatility index (VIX) has surged to 45. The extremely complacent market situation at the beginning of the year (factors such as Trump protectionism, optimism, and deregulation) has clearly undergone a significant adjustment. Historically, when the VIX index surges significantly without the economy falling into recession, the stock market rises 85% of the time (see page 7).

Here, the last point is crucial, we believe the situation remains pessimistic in the short term. We think that the adverse factors in trade and fiscal policy, combined with companies possibly increasing orders in advance of tariff implementation, as well as high inflation expectations affecting real disposable income, will continue to weaken economic growth momentum. Last week's "tariff adjustment day" may mark the peak of trade uncertainty, but it is certainly not the end, especially considering potential retaliatory measures. In any case, the tariff issue still needs to be continuously monitored to encourage companies to make concessions and ultimately relocate production back to the U.S. Even if some tariffs are lifted, the negative impact on market sentiment may not change.

We believe investors should remain cautious about risks, as the aforementioned situations may continue to lead to a weakening of the S&P 500 index, relatively better performance of defensive stocks, declining bond yields, and a further flattening of the yield curve.

To continue buying stocks, we need to see trade issues resolved in addition to technical rebounds. This not only requires a shift in fiscal policy (which may require some changes from the current administration) but also a loosening of monetary policy by the Federal Reserve, which may only happen after a true economic recession arrives. Ultimately, we will enter a more decisive phase of Federal Reserve support, driving the yield curve to steepen and the stock market to recover, but this is unlikely to occur before the second half of 2025.

Overall, we pointed out at the beginning of this year that the current market is significantly different from the situation in 2017. Factors such as excessively high starting positions, adverse policies, and a weak economic growth backdrop sharply contrast with the continuous rise of the S&P 500 index in 2017. At that time, it was a re-inflation environment, while now it is a stagflation environment. Based on these factors, we believed in our outlook at the beginning of the year that the market might weaken first before potentially showing better performance.

We also maintain that U.S. tech stocks, the "Magnificent Seven" (Mag - 7), and growth stocks will not serve as safe havens by the end of summer as they did in the past two years. We recommend sector rotation in a soft landing style and reducing holdings in semiconductors. On the other hand, we believe Chinese tech stocks remain attractive. The driving factors are as follows:

(1) Soft data may indicate that future hard data will be disappointing, and the U.S. government may take further action. We believe that the tariff issue will certainly not disappear (2) The Federal Reserve is in a dilemma and may remain inactive in the face of rising inflation expectations.

(3) The first quarter earnings season is approaching, and companies may struggle to announce too many positive news. Revenue declines and trade uncertainties may trigger widespread profit warnings.

(4) The forward price-to-earnings ratio in the U.S. is 19 times, which still appears too high. International market valuations are lower, but it is unlikely to decouple from the U.S. market.

(5) Positions and restrictions have not yet been sufficiently tightened, especially as an economic recession becomes a reality. Institutional investors' positions are still higher than the lows of 2016 and 2022, and the total asset allocation weight is also at a record high