Getty Images; Jenny Chang-Rodriguez/BI
Investors are lingering in defensive trades that don't take advantage of the economy's strength, Morgan Stanley said, highlighting opportunities in underinvested sectors.
The firm — which just last week upgraded cyclical stocks to "overweight" relative to defensives — described the financials group as particularly attractive.
Morgan Stanley said net exposure to financials was in the bottom 15th percentile of a historical data series that goes back to 2010. And as the chart below shows, it's the most lightly owned of any sector.
Morgan Stanley
But Mike Wilson, the bank's chief investment officer and chief US equity strategist, sees a combination of headwinds that could lift financial stocks.
"In our view, this creates opportunity in [the financial] sector that we upgraded to overweight last week given: rebounding capital markets activity, a better loan growth environment in 2025, an acceleration in buybacks post Basel Endgame re-proposal, and attractive relative valuation," he wrote.
Bank stocks also have had more attractive valuations since de-risking last month, after large-cap dealers signaled caution on their operating environment. Morgan Stanley noted that this weakness lowered earnings-season expectations for investors, making it easier for major lenders to outperform forecasts.
JPMorgan and Wells Fargo have jumped since publishing better-than-expected earnings reports last week: They're up by 3.8% and 8.8% since Friday's open.
Despite this, Wilson found, the market's appetite for financials hasn't materialized. This isn't limited to bank stocks — investors are passing up on other cyclical sectors, concentrating exposure in defensive and quality names.
Utilities, healthcare, and real estate — which are defensive plays — are among the four sectors with high net exposure.
Wilson argued that this shows that investors are still positioning themselves for a soft-growth scenario, which seems less likely in light of recent macroeconomic trends.
Though Morgan Stanley moved to neutral on cyclicals versus defensives late last month, it upgraded cyclicals to overweight last week after September's jobs report surged past Wall Street forecasts.
"As several key macro data points have come in better than expected (namely the jobs report and the ISM Services Index) following the Fed's 50bp rate cut, cyclicals have begun to show relative strength," Wilson said.
At the same time, rates-market yields are moving higher, indicating that growth concerns are falling.
The note said cyclicals such as industrials, financials, and energy move up when yields rise, whereas defensive stocks are negatively correlated with higher rates.
