Volatility could take the markets by surprise over the summer, believe analysts at Morgan Stanley. Of course this may not necessarily be a bad thing, and if history tells us anything, it shouldn’t be a surprise if the summer brings volatility with it.
The summer of volatility?
In a report dated June 2, Morgan Stanley analysts explain Andrew Sheets, their firm’s chief cross-asset strategist, believes that the markets aren’t pricing in a high enough potential for volatility during the summer months.
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The firm’s report states that expected volatility for U.S. stocks in the next three months is quite a bit lower than the long-run average. This is particularly interesting because the June to September period has been bringing larger moves to the markets in recent years, especially when it comes to pitching off the downside, compared to the rest of the year.
Sheets sees a number of basic catalysts that could cause volatility to go higher over the summer, including the upcoming Brexit referendum in the U.K. He also believes this month’s elections in Spain and the potential for economic recovery in China could make the summer months more volatile to the markets. Morgan Stanley’s Economics team believes that China’s recovery could slow over the next several months. Also the firm’s Commodities team is skeptical that the recovery we’ve seen in oil prices is sustainable.
Volatility a good thing?
Sheets also believes that it may not be a bad thing to own volatility right now in light of the fact that market liquidity is now structurally lower.
Seeking Alpha contributor Mark Hebner made the case that volatility is actually a good thing in a post on Thursday. He notes that it means the markets are functioning property and argues that it means the prices are “digesting information and setting positive expected return going forward.” He also states that history teaches that in most cases, steep market declines typically result in “favorable returns for investors over subsequent short-term periods.”
Of course what makes it so challenging to invest during volatile periods in the markets is that it becomes even more difficult than usual to predict what’s going to happen. However, there are some stocks that may be seen as a safer bet than others. Morgan Stanley analysts put together their own list of stocks that they describe as offering low volatility with “favorable return prospects.”
Low volatility stocks dominated by Consumer Staples
Specifically, the firm considers these stocks to be among the lowest-beta stocks for the next 63 trading days and offer a possible “total return” or “return to base-case valuation + dividend yield” of at least 3%. Morgan Stanley analysts then excluded a list of stocks based on their 90-day and 180-day call option implied volatility. Most of the stocks on their list fall into the categories of Consumer Staples, real estate investment trusts, and Utilities, although they also had a number of Consumer Discretionary and Healthcare stocks on their list as well.
Among the stocks they recommend are Dunkin’ Brands, Dollar General and Darden Restaurants in Consumer Discretionary. In Consumer Staples, they like Coca-Cola, PepsiCo, Dr. Pepper Snapple, and Costco, among others, while in Financials, they like Paramount Group, STORE Capital, and Simon Property Group. Interestingly, they name Verizon Communications, which has taken a huge hit from the ongoing worker strike recently. Other firms have also mentioned Verizon as a top pick as well, for its valuation and high dividend yield. In Utilities, Morgan Stanley likes Entergy, Duke Energy, and Dominion Resources, among others.