Investors are lagging behind again! Morgan Stanley: It's time to buy cyclical stocks

Morgan Stanley stated that investors are still engaged in defensive trading, not fully utilizing the strong performance of the U.S. economy, and emphasized opportunities in undervalued industries.

Morgan Stanley recently upgraded its rating for cyclical stocks to "Overweight" instead of defensive stocks. The company mentioned that the financial sector is particularly attractive.

According to Morgan Stanley, the net exposure to financial stocks has been in the bottom 15th percentile based on a series of historical data since 2010.

Mike Wilson, the Chief Investment Officer and Chief U.S. Equity Strategist at the firm, identified several factors that could drive up financial stocks.

He wrote, "With rebounding capital market activity, improved loan growth environment by 2025, accelerated buybacks following the re-proposal of the Basel Accord, and attractive relative valuations, we see opportunities created for the (financial) industry. We upgraded our rating for this sector to Overweight last week."

Since the risk-off sentiment last month, bank stocks have become more attractive. Previously, major traders had sent cautious signals about their operating environment, and Morgan Stanley noted that this softness lowered investors' expectations for earnings season, making it easier for major banks to exceed expectations.

Since releasing better-than-expected earnings reports last week, JPMorgan Chase and Wells Fargo stock prices have risen.

However, Wilson found that the market's interest in financial stocks has not materialized. This is not limited to bank stocks—investors are missing out on opportunities in other cyclical industries, concentrating risk exposure on defensive and quality stocks.

Utilities, healthcare, and real estate are defensive stocks and belong to the four industries with higher net exposure.

Wilson believes that this indicates investors are still preparing for a low-growth scenario in the U.S., which seems unlikely given recent macroeconomic trends.

Although Morgan Stanley had a neutral rating on cyclical stocks at the end of last month, it adjusted its rating after the September jobs report significantly exceeded Wall Street's expectations.

Wilson said, "With several key macroeconomic data points better than expected after the Fed's 50 basis point rate cut (mainly the jobs report and ISM service sector index), cyclical stocks are showing relative strength."

Meanwhile, yields in the interest rate market are rising, indicating diminishing concerns about growth.

The report pointed out that when yields rise, cyclical stocks like industrials, financials, and energy rise, while defensive stocks are negatively correlated with higher rates