As the U.S. economy's position within the business cycle remains uncertain, investors are being encouraged to focus on late-cycle stock sectors. The recommendation comes from Mike Wilson, Morgan Stanley (NYSE:MS)'s chief U.S. equity strategist, who advised maintaining a barbell portfolio until more definitive data emerges.
Wilson's proposed barbell portfolio would balance defensive growth sectors like healthcare and consumer staples with late-cycle cyclicals such as industrials and energy. Despite underperformance this year, Wilson emphasized that it is premature to shift investments towards small to mid caps, citing the Russell 2000 RUT's mere 4% increase in 2023.
The energy sector has been attracting investor attention due to rising crude prices, recently nearing $92 per barrel. Wilson views this sector as a typical late-cycle outperformer, often buoyed by commodity strength. He pointed to strong oil demand, significant production cuts, and stable crude prices as factors supporting the sector's performance.
The energy sector's appeal is further boosted by its recovery from an underperformance period that spanned from November last year until July this year. Currently, the sector presents attractive valuations and accelerated earnings revisions, while generating substantial free cash flow and having the ability to pay off debt if needed. This recovery occurs as hedge fund exposure to the energy sector remains historically low.
Wilson also spotlighted a range of defensive growth stocks that have outperformed both yearly and more recently. These stocks, all rated overweight by Morgan Stanley, include Accenture (NYSE:ACN) ACN, Apple (NASDAQ:AAPL), AutoZone (NYSE:AZO) AZO, Biomarin Pharmaceutical BMRN, and Boston Scientific (NYSE:BSX) BSX.
Most U.S. investors expect that large-cap winners will continue to lead during the fourth quarter if the broader market remains stable. Wilson observed similar concerns among European and U.S. clients regarding the current economic cycle stage and performance disparities.
Investors are pondering whether the rest of the year will see continued dominance by mega cap growth or a shift towards underperforming areas such as value and small/mid cap stocks. However, Wilson maintains that it may still be too early for such a transition.
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