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For
months, investors have been bracing for a "soft landing" for the
economy, which sees tepid growth alongside inflation falling
from high levels.
"However, the macro data and equity market leadership have
started to support the no landing outcome," Morgan Stanley
strategists led by Michael Wilson said in a note.
Strong economic data and firmer-than-estimated inflation reports
have also reduced expectations for Federal Reserve interest rate
cuts. Traders in fed fund futures on Monday were betting on a
total of 62 basis points of rate cuts this year, down from
January estimates of 150 basis points.
Sectors often linked to economic growth, such as financials,
energy and industrials, have all put up strong performances so
far this year, topping the S&P 500's 9% rise in 2024, while
materials -- another economically sensitive group -- has also
performed well.
This strength contrasts with last year, when a narrow group of
megacap tech and growth stocks accounted for the bulk of the
index's gains.
"This broadening is being led by cyclical industries... which is
supportive of the notion that the equity market is beginning to
process a better growth environment," Morgan Stanley said in the
note.
While cyclically sensitive stocks and sectors have started to
outperform, quality remains a key attribute for the leaders, the
Morgan Stanley strategists noted.
The emphasis on quality "makes sense in the context of what is
still a later cycle rather than an early cycle reacceleration in
growth," they said.
If the growth pickup was early cycle, there would be more
persistent outperformance by small-cap stocks and lower quality
cyclicals, Morgan Stanley said.
The small-cap Russell 2000 is up only 2.4% this year.
The direction of Treasury yields could also play a role in how
economically sensitive parts of the market perform, Morgan
Stanley said. The 10-year Treasury yield was last at 4.42%,
above the 4.35% level at which Morgan Stanley previously said
stocks could become more sensitive to yields.
While downside in yields could prompt rotation to a broader
group of cyclicals, "a break higher in yields could take us back
into a narrow market regime," the strategists said.
(Reporting by Lewis Krauskopf; Editing by Bill Berkrot)
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