Are investors overlooking financial stocks in favor of defensive trades? Morgan Stanley thinks so
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- Morgan Stanley highlights significant undervaluation in financial stocks as investors prefer defensive trades.
- Financials are in the bottom 15th percentile of net exposure, making them the least owned sector since 2010.
- Mike Wilson cites rebounding capital markets and improved loan growth for upgrading financials to overweight.
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Investors are currently focused on defensive trades, missing out on the strength of the economy, according to a report from Morgan Stanley.
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The firm has identified significant opportunities in underappreciated sectors, particularly within financial stocks.
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Recently, Morgan Stanley upgraded cyclical stocks to an “overweight” position compared to defensive sectors.
The report emphasizes that net exposure to financials is alarmingly low, residing in the bottom 15th percentile of historical data dating back to 2010.
As illustrated in accompanying charts, the financial sector is the least owned compared to others.
Mike Wilson, the bank’s chief investment officer and head of US equity strategy, pointed out several factors that could positively impact financial stocks.
He stated:
In our view, this creates opportunity in [the financial] sector that we upgraded to overweight last week given: rebounding capital markets activity, a better loan growth environment in 2025, an acceleration in buybacks post Basel Endgame re-proposal, and attractive relative valuation.
Bank stocks have become increasingly appealing due to improved valuations following a de-risking phase last month, during which large-cap dealers expressed caution about their operating conditions.
This caution has led to lowered expectations for earnings season, allowing major lenders to surpass forecasts more easily.
Following the release of better-than-expected earnings reports last week, both JPMorgan and Wells Fargo have seen notable increases in their stock prices, rising by 3.8% and 8.8%, respectively, since Friday’s market open.
Despite these developments, Wilson observed a continued lack of market interest in financial stocks.
This trend extends beyond banking; investors are largely shunning other cyclical sectors, opting instead for defensive and quality stocks.
Utilities, healthcare, and real estate, which are considered defensive plays, account for some of the highest net exposure in investor portfolios.
Wilson contended that this positioning indicates investors are preparing for a soft-growth scenario, which seems increasingly unlikely based on recent macroeconomic trends.
Although Morgan Stanley had previously shifted to a neutral stance on cyclicals versus defensives at the end of last month, the firm upgraded cyclicals to an overweight position last week after the jobs report exceeded Wall Street expectations.
“As several key macro data points have come in better than expected (namely the jobs report and the ISM Services Index) following the Fed’s 50bp rate cut, cyclicals have begun to show relative strength,” Wilson noted.
Additionally, rising yields in the rates market suggest diminishing growth concerns.
The report indicates that cyclical sectors such as industrials, financials, and energy typically perform better when yields increase, while defensive stocks tend to decline in response to rising rates.
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