By Louis Kraskopf
NEW YORK (Reuters) – Recent activity in the U.S. stock market suggests investors are starting to price in a „no landing” economic scenario, including an expected pickup in growth, Morgan Stanley equity strategists said on Monday.
For months, investors have been bracing for a „soft landing” for the economy, which is seeing moderate growth with inflation falling from high levels.
„However, macro data and stock market leadership are beginning to support a bearish decision,” Morgan Stanley, led by Michael Wilson, said in a note.
Strong economic data and firmer-than-estimated inflation reports dampened expectations for Federal Reserve interest rate cuts. Traders in Fed funds futures on Monday were betting on a total of 62 basis points of rate cuts this year, down from a January estimate of 150 basis points.
Sectors associated with economic growth, such as financials, energy and industrials, have all shown strong performance so far this year, leading the S&P 500 to gain 9% in 2024, while commodities — another economically sensitive group — have outperformed. .
This strength contrasts with last year, when a narrow group of megacap technology and growth stocks accounted for the bulk of the index's gains.
„This expansion is led by cyclical industries … which supports the view that the stock market is beginning to implement a better growth environment,” Morgan Stanley said in a note.
As cyclically sensitive stocks and sectors begin to outperform, quality remains an important attribute for leaders, Morgan Stanley strategists noted.
Emphasis on quality, they said, „makes sense in the context of an even later cycle rather than re-accelerating the initial cycle in growth.”
If growth picks up early in the cycle, small-cap stocks and low-grade cycles will have more consistent performance, Morgan Stanley said.
The small-cap Russell 2000 is up just 2.4% this year.
Morgan Stanley said the direction of Treasury yields could also play a role in how economically sensitive parts of the market perform. The 10-year Treasury yield was last at 4.42%, well above the 4.35% level at which Morgan Stanley previously said stocks would be more sensitive to yields.
While negativity in yields could trigger a cycle for the broader cyclical group, „a wider gap in yields could take us back into a short market regime,” strategists said.
(Reporting by Louis Kraskopp; Editing by Bill Berkrot)
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