Key Points
- Morgan Stanley upgraded cyclical stocks to “Overweight” due to strong labor data and expected Fed rate cuts.
- Cyclical sectors like airlines and automakers are poised to benefit from a soft economic landing.
- Defensive sectors, such as healthcare and staples, were downgraded, but utilities remain favored.
- US labor market data exceeded expectations, with 254,000 jobs added in September and unemployment falling to 4.1%.
Morgan Stanley analysts have shifted their focus to cyclical stocks following resilient US labor market data and an anticipated series of Federal Reserve interest rate cuts. In a note to clients on Monday, the analysts said that strong job numbers bolster investor confidence that the Fed will achieve a “soft landing”—where elevated inflation is controlled without triggering a broader economic downturn or increasing unemployment.
Cyclical stocks, sensitive to economic trends, are expected to outperform in this environment. These stocks typically represent businesses offering discretionary goods or services, such as airlines or automakers, that benefit from improving economic conditions. As a result, Morgan Stanley upgraded its outlook on cyclical stocks from “Neutral” to “Overweight,” signaling a strong recommendation for investors to increase exposure to this sector.
On the other hand, the firm downgraded its outlook for defensive stocks, which include businesses that remain profitable regardless of economic trends, such as healthcare and consumer staples. Healthcare was reduced to “Neutral,” while consumer staples were shifted to “Underweight,” indicating a less favorable view. However, the analysts maintained an “Overweight” position on utilities as a defensive hedge, citing the sector’s potential for steady growth even in volatile markets.
The positive sentiment around cyclical stocks follows strong US jobs data. According to the Labor Department’s report, the US economy added 254,000 jobs in September, surpassing economists’ expectations of 147,000. The unemployment rate also dropped to 4.1%, slightly below August’s rate of 4.2%. Additionally, average hourly wages rose by 0.4% in September, above predictions of 0.3%, although slower than August’s revised 0.5% increase.
Due to this labor market strength, market expectations for a larger interest rate cut have diminished. The Federal Reserve, which recently implemented a 50-basis-point rate cut, is now expected to reduce rates by a more moderate 25 basis points. The CME Group’s FedWatch Tool shows a 94.5% probability of a quarter-point rate cut, with only a 5.5% chance of no change to the current 4.75% to 5.00% range.
Last week, US equity markets reflected this positive sentiment, with the Dow Jones Industrial Average posting a record high. The Nasdaq Composite gained 1.2%, while the S&P 500 increased 0.9%, showing broad confidence in the market’s future.
