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Is the market presenting a renewed chance to invest in cyclicals?
Morgan Stanley's Chief U.S. Equity Strategist Mike Wilson asserts that it is.
While the S&P 500 remains up approximately 13% year-to-date, there has been significant movement beneath the surface:
- 54% of Russell 3000 stocks have declined over 20% since June, indicating a quiet bear market.
- The forward price-to-earnings (P/E) ratio for the S&P 500 has returned to around 19x, close to levels observed in March.
- Earnings per share (EPS) growth is still in the mid-teens, with more upgrades than downgrades.
Wilson noted, "That combination suggests the derating is much further advanced than the index price level alone would imply."
In other words, stocks have decreased, but the fundamentals remain strong, presenting an opportunity.
Morgan Stanley believes that industrials offer the best risk/reward profile.
1. The market has transitioned to asset-light services, impacting asset-heavy industrials like Caterpillar ($CAT ), General Dynamics ($GD), and United Rentals ($URI), which have become appealing following their de-rating.
2. Industrials are experiencing 38% net upgrades compared to 16% in February, despite price declines. The rate of price gain has decreased from 49% to 10% year-over-year.
3. Stability in oil prices, interest rates, and the dollar may benefit cyclicals that have been neglected, such as Consumer Discretionary, Transports, and Regional Banks.
4. If the 2-year yield, currently around 5%, stabilizes, Wilson foresees two potential outcomes: either breadth catches up to price levels, or a final index correction of 5-10% that concludes the ongoing multi-month correction, both of which would be bullish for year-end.
"We continue to favor quality, but the amount of price damage in the average stock is beginning to create a better setup for cyclical areas where fundamentals remain intact," stated Mike Wilson.
- Maintain positions in Large-Cap Quality stocks (asset-light, services, fee-based).
- Begin to increase cyclical exposure over the next month, particularly if the S&P 500 weakens to around 7,205 (200-day moving average) — currently at approximately 7,743.
- Recommended sectors include Industrials, Financials, Small-Caps, and Healthcare.
Wilson reiterated a target of 7,800 for the S&P 500 by 2026, suggesting around 18% upside potential from current levels, supported by anticipated Federal Reserve cuts and advancements in AI efficiency.
The shift towards cyclicals indicates a risk-on environment. Historically, when stock performance broadens beyond MegaCap Technology, liquidity tends to flow into high-beta assets as well. Observing the breadth of the $SPX could serve as an indicator for a potential altcoin season.
Will cyclicals lead the next upward trend?
$SPX $CAT #stocks #MorganStanley #Investing"