Investors looking for clues about the current state of the U.S. economy should turn their attention to late-cycle stock sectors that are currently showing signs of growth.
According to Mike Wilson, chief U.S. equity strategist at Morgan Stanley, sticking with the late-cycle playbook is the smartest move until more concrete data becomes available. Wilson also believes that markets will behave in a late-cycle manner.
In light of this, Wilson recommends constructing a barbell portfolio that includes defensive growth on one side and late cycle cyclicals on the other. The defensive growth portion should consist of select growth stories and traditional defensive sectors like healthcare and consumer staples. On the other side, investors should consider late cycle cyclicals such as industrials and energy.
Wilson advises against pivoting too early when it comes to investing in small to mid caps, even though they have underperformed this year. The Russell 2000 index, for example, has only seen a 4% increase in 2023.
Within the late cycle cyclicals, Wilson's preference is for the energy sector. Recent surges in crude oil prices have brought energy to the forefront of investors' attention. On Monday, crude oil prices reached new highs for 2023, approaching $92 a barrel.
Historically, the energy sector performs well in late-cycle environments, particularly when supported by commodity strength. Wilson notes that current oil demand is strong, significant production cuts have been made, and commodity strategists expect crude prices to remain stable at their current levels.
Read: This hot sector is producing returns like Nvidia’s — and it’s got nothing to do with AI
Wall Street's Outlook on the Energy Sector: A Promising Turnaround
The energy sector has been underperforming since last November, but it is finally showing signs of life. Many strategists are optimistic about this turnaround, citing attractive valuations and increased earnings revisions within the sector. In fact, hedge funds' exposure levels to energy are at historic lows, indicating potential for substantial gains.
One strategist, Wilson, identifies defensive growth stocks that have consistently outperformed throughout the year and are currently rated overweight by Morgan Stanley. These stocks include Accenture, Apple, AutoZone, Biomarin Pharmaceutical, and Boston Scientific.
Despite this optimism, Wilson acknowledges that most U.S. investors still expect large-cap winners to maintain their lead in the fourth quarter, assuming the broader market remains stable. During their recent visit to European clients, Wilson's team identified similar concerns about economic cycles and narrow performance.
Going forward, market participants are speculating whether the remainder of the year will continue to favor mega cap growth stocks or if there will be a shift towards undervalued assets and small/mid cap stocks. However, Wilson suggests that it might still be too early to make any definitive conclusions.
Also read: Wall Street's Optimism: Industries Expected to Shine in the Fourth Quarter
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