Morgan Stanley analysts warn that slowing economic growth poses a risk for US stocks, particularly for cyclical and value-oriented sectors.
The bank's note highlights the importance of focusing on large-cap quality and defensive stocks in this environment.
"With economic surprise indices and bond yields falling, many stocks are now becoming more sensitive to softer growth conditions," the bank states. This shift, according to Morgan Stanley, makes earnings growth a more critical factor for stock performance.
The bank finds that value and cyclical stocks, especially those in the small-cap space, are particularly vulnerable. While falling interest rates might traditionally benefit these areas, Morgan Stanley argues that lower rates, in this case, reflect slowing growth and pricing power, negating any potential upside.
Conversely, Morgan Stanley observes positive trends in large-cap, quality stocks. Earnings revisions breadth is said to be positive for both the S&P 500 and Nasdaq 100, while "large cap trailing earnings growth is also pushing higher. These factors solidify Morgan Stanley's preference for this segment of the market.
Looking ahead to a potential rate-cutting cycle by the Federal Reserve, Morgan Stanley reiterates its stance favoring large-cap growth stocks.
"Our work shows that it's large-cap growth that sees the strongest performance on a persistent basis once the Fed starts lowering rates," the note concludes. They believe this aligns with a late-cycle scenario where investors seek out quality and long-term growth prospects.