The strong jobs report leads Morgan Stanley to ditch a stock-market call it made just two weeks ago

By Steve Goldstein

Morgan Stanley says it's now overweight cyclical stocks

Markets were having a bit of a breather Monday morning after the big rally following the much better than expected jobs report.

S&P 500 futures (ES00) slipped 0.5%, after a 0.9% gain for the index SPX on Friday.

Morgan Stanley strategists led by Mike Wilson say the reaction on Friday was to be expected, because the market is currently is in a "good is good" environment - which is demonstrated now by the positive correlation between stock market returns and bond yields.

"In our view, 'good' (growth/labor data) will be particularly "good" for quality cyclicals. These stocks have upside exposure to better macro data and yet, due to stronger balance sheets, aren't as adversely exposed to a higher yield environment," they say.

But it does mean that the firm is junking its call of just two weeks ago, when it went neutral on cyclicals versus defensives. In its defense, Wilson and team say that trade was dependent on the labor data. "In line with this framework, Friday's strong jobs data and our economists' call for a series of 25bps rate cuts from here lead us to upgrade cyclicals to overweight relative to defensives," the firm says.

That results in Morgan Stanley lifting financials to overweight, downgrading healthcare to neutral, and downgrading staples to underweight (though retaining an overweight on utilities, as a defensive hedge).

On financials in particular, it notes that Morgan Stanley analysts expect M&A and capital markets deal flow picking up as the Fed cuts interest rates in a soft-landing environment, as well as a significant acceleration in buybacks once the new Basel capital rules are re-proposed.

It adjusted its fresh money buy list to align with this stance, adding Bank of America (BAC) and Eaton (ETN) while removing SBA Communications (SBAC).

It's also taking profits on its long-standing large-cap overweight, as it's now neutral on large vs. small caps. "We have been vocal that a rate-cutting cycle in and of itself does not justify small cap outperformance, in our view. However, an outsized start to a rate-cutting cycle combined with a much stronger than expected payroll print does make the risk-reward for a large cap overweight less attractive, at least tactically," the strategists said. It does recommend "quality" small caps, companies that have stronger margin and balance sheet profiles.

The iShares Russell 2000 ETF IWM gained 1.4% on Friday but has underperformed the S&P 500 this year, rising 9% to the larger index's 21%.

-Steve Goldstein

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10-07-24 0528ET

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