No time to turn defensive on Wall Street; Morgan Stanley says there’s more steam in cyclical trades

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Economic growth ahead could be much broader and stronger than any of the cycles seen earlier.
(Image: REUTERS)

Some Wall Street investors have switched back to defensive trades after a strong rally in equity indices saw them surge to record highs. Investors moved their focus towards defensive, choosing large-caps over mid-cap and small-caps, and went for growth stocks instead of value. However, this move towards defensives might be pre-mature, according to Lisa Shalett, Chief Investment Officer, Morgan Stanley Wealth Management. “We disagree and believe that a defensive shift for investment portfolios is premature. In our view, recent events represent a pause — not a reversal — in the reflation trade,” she added.

The shift towards defensive sectors signals that earning expectations already price in most of the post-pandemic good news, ranging from the economic rebound to re-opening. Economic growth ahead, however, could be much broader and stronger than any of the cycles seen earlier. “Fiscal spending, with its emphasis on infrastructure, would be inherently linked to greater “capital deepening,” in which capital per worker is increasing in the economy,” Lisa Shalett wrote in a blog.

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Further, inflation is expected to be accompanied by improving demographics and faster credit growth. “The latter element should kick in after huge pent-up demand and excess savings are exhausted,” she said. Meanwhile, economic gauges have continued to report better figures as March retail sales in the US were up 9.8% from February.

Lisa Shalett believes it is time for investors to rebalance their portfolios but keep cyclicals and value stocks at the core. “Our research suggests that value-investing tends to outperform growth-investing during above-average economic growth and rising inflationary expectations; we expect both conditions to persist in the new business cycle,” she said. Shalett added that stretched valuations are likely to shift investors to growth at a reasonable price strategy.

Investors are being advised to watch for growth indicators along with inflation expectations while continuing to refocus away from long duration and rate-sensitive sectors in both bonds and stocks, and toward pro-cyclical, short duration, value and quality.

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