Investors stumped as to where the U.S. economy is situated in the current business cycle, should be focusing on late-cycle stock sectors, which includes one that has been heating up of late.
“Stick with the late cycle playbook for now,” Mike Wilson, chief U.S. equity strategist at Morgan Stanley, advised clients in a note on Sunday. He says that’s the smartest choice until more “definite data” comes in, as he also thinks markets will behave in a late-cycle manner as well.
With that, he suggests they hold a so-called barbell portfolio containing defensive growth — select growth stories and more traditional defensive sectors like healthcare and consumer staples — on one side — and late cycle cyclicals, such as industrials and energy, on the other.
Wilson says when it comes to investing in small to mid caps, “it’s too early to pivot,” even if they’ve been big underperformers this year, with the Russell 2000
RUT
up just 4% in 2023.
Within those cyclicals, their preference is energy, a sector that is pole-vaulting into the investor psyche lately thanks to surging crude prices , which on Monday continued a push to new 2023 highs, inching closer to $92 a barrel.
“The sector is historically a late cycle outperformer that is often supported by
commodity strength in such backdrops. In today’s environment, oil demand is
strong, production cuts have been significant and our commodity strategists
see crude prices underpinned around current levels,” said Wilson.
Read: This hot sector is producing returns like Nvidia’s — and it’s got nothing to do with AI
The strategist ticked off several more reasons why they are keen on the energy sector, such as an underperformance that stretched from last November to July, and is now coming to life, though with attractive valuations. And earnings revisions have speeded up for energy and many of the sector’s subgroups, with plenty of free cashflow generation and the ability to pay off debt if needed. That’s as hedge funds exposure levels to the energy sector are at an historic low.
Wilson offered up a screen of defensive growth stocks, which have outperformed on a year-to-date basis, as well as more recently. All the stocks are rated overweight by Morgan Stanley. The top five include Accenture
ACN,
Apple, AutoZone
AZO,
Biomarin Pharmaceutical
BMRN,
and Boston Scientific
BSX,
Here’s a rundown of the rest:
He adds that most U.S. investors still expect large-cap winners will continue to lead in the fourth quarter if the broader market holds together. They recently visited clients in Europe and found lots of similarities with those in the U.S., such as grappling with where economies are in the cycle and narrowness of performances.
“As such, most are wondering if the rest of the year will bring more of the same (mega cap growth leadership) or whether markets will pivot and broaden out to areas that have underperformed YTD [year to date]—i.e., value and small/mid cap stocks,” he said. And as Wilson reiterated above, it still may be too early for that.
Also read: Wall Street is the most optimistic on these industries as the fourth quarter approaches
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