Morgan Stanley Shifts to Neutral Stance on Defensives Versus Cyclicals

Morgan Stanley has updated its outlook on Defensive versus Cyclical stocks to neutral, according to a statement released on Monday.

The firm’s strategists indicated that this change comes after the significant performance of Defensive stocks, which have reached elevated valuation levels. They emphasized the necessity of awaiting clearer indications from upcoming labor market data before making any decisive market moves.

Historically, Defensive stocks tend to perform well in the three to twelve months following the Federal Reserve’s initial rate cut. However, they generally experience some underperformance in the month immediately following the cut.

This trend is particularly relevant now, as noted by Morgan Stanley, in light of the Fed’s unexpected 50-basis point cut.

“Taking profits from the recent outperformance of defensives seems prudent given the uncertainty surrounding the forthcoming labor report,” the strategists commented.

They believe that labor market data will be a critical factor influencing equity performance as the year progresses. A robust labor report, indicated by a decline in unemployment rates and stronger-than-expected payroll figures, could create a favorable environment for Cyclical stocks. Conversely, weaker labor data accompanied by a rise in unemployment may lead to a risk-off sentiment in the market, according to the strategists.

Morgan Stanley continues to prefer large-cap stocks over small-cap, as large caps typically perform better during the mid-to-late stages of the economic cycle.

“This observation reflects consistent outperformance following the Fed’s first cut. Additionally, large-cap earnings revisions are showing breadth and generally outperform small caps in these economic phases,” the strategists explained.

They also hold an overweight position in the Industrials sector, viewing it as well-positioned among Cyclicals due to favorable earnings revisions, reasonable valuations, and positive structural drivers.