Morgan Stanley strategists have upgraded their outlook on cyclical stocks, emphasizing that the continued stabilization of the economic surprise index is likely to boost the performance of quality cyclicals, even as bond yields rise. They believe that positive correlations between cyclicals and interest rates are a key reason for this shift, as economic resilience drives investor confidence in sectors that benefit from growth.
Cyclicals vs. Defensives
The Wall Street firm recently shifted its focus from defensive stocks to cyclical ones, citing stronger macroeconomic data that supports their bullish view on cyclicals. Cyclical stocks, which are closely linked to economic growth, tend to perform well when interest rates rise and economic data remains robust. In contrast, defensive stocks are negatively impacted by higher yields, as these stocks usually thrive during periods of economic uncertainty.
“This confirmation gives us more confidence in our recent upgrade of cyclicals relative to defensives,” the strategists noted in a report released Monday.
Upgraded Outlook on Financials
Morgan Stanley has also upgraded the financial sector to overweight, highlighting several positive factors like improving capital markets activity and a favorable loan growth environment projected for 2025. The firm pointed to potential buyback accelerations following the Basel Endgame re-proposal and the sector’s attractive relative valuations.
Bank stocks, in particular, have been de-risked following conservative guidance from large-cap banks in September. This has set a lower bar for earnings expectations, which many banks are now exceeding, creating more upside potential for the sector.
Election-Year Dynamics
As the focus shifts to the upcoming US election, Morgan Stanley strategists emphasized three key dynamics:
- Business Cycle Over Politics: They believe the business cycle’s influence on markets is more critical than the election outcome itself.
- Volatility Patterns: Volatility often increases during election years, peaking in September and October before easing in November.
- Preference for Quality Assets: Historical trends suggest that quality assets typically outperform during election years, making them a strategic choice for investors navigating the uncertainty.
Morgan Stanley’s overall message is clear: stabilization in the economic surprise index and resilient growth data are reasons to be optimistic about quality cyclicals and the financial sector, even amid higher yields and potential market volatility.
