Take profits on defensive stocks, says Morgan Stanley

Investors should lock in gains on US defensive stocks as their recent outperformance has left valuations looking pricey, according to Morgan Stanley strategists.

The team led by Michael Wilson turned neutral on so-called defensives relative to economy-linked cyclical sectors, saying they are awaiting “more clarity” on jobs data, which they see as a key driver for stocks into the year end.

“Taking profits on the recent outperformance of defensives makes sense in the absence of knowing the outcome of the next labor report,” the strategists wrote in a note.

Investors have flocked to stocks that are considered relatively immune to an economic downturn — such as healthcare and utilities — in the past few months amid worries about a recession in the US. A Citigroup Inc. basket of defensives has risen about 11% since the end of June, outperforming an 8.5% advance in the equivalent cyclicals index.

But last week’s Federal Reserve interest-rate cut — the first in in four years — has helped alleviate growth concerns. The S&P 500 Index hit a record high following the decision, and traders expect more easing before the end of the year.

The Morgan Stanley team said that defensives typically tend to suffer “modest” underperformance in the month following the Fed’s first rate reduction. However, the group posts a “fairly persistent outperformance” over a three-to-12-month horizon, they said.

Wilson was among the most notable bearish voices on stocks until mid-2024. In the note Monday, he reiterated his preference for large-cap stocks with a robust earnings outlook.

Other market strategists including at Citigroup and Barclays Plc have also turned more optimistic about the outlook for cyclicals, particularly in Europe. Sectors that are more sensitive to macroeconomic factors, like automakers and retail, make up a big part of the benchmark index in the region. 

However, JPMorgan Chase & Co. strategist Mislav Matejka said he remained bearish on European cyclical stocks amid an expected drop in bond yields, earnings downgrades and “unattractive valuations.”