- Financials have outperformed this earnings season.
- That proves cyclical stocks are poised for gains, Morgan Stanley says.
- Cyclical shares are set to be rewarded for beating lowered earnings expectations, the bank said.
As earnings season heats up there's one corner of the stock market that's outperforming expectations, Morgan Stanley says.
Analysts at the bank say that cyclicals—stocks that follow the rough trajectory of the economic cycle—have beaten estimates across the board so far, indicating that cyclical shares yet to report are primed for big earnings beats.
Cyclicals tend to be more economically sensitive, rising and falling with the economy's growth cycle. The group includes stocks in the industrials, financials, and energy sectors. They stand apart from defensive stocks, which tend to be safer bets when the economy is weakening and include sectors like consumer staples, utilities, and healthcare.
The analysts, led by the bank's chief investment officer, Mike Wilson, cite a lower earnings bar as the key reason for their bullishness in this sector of the stock market.
Third-quarter consensus earnings-per-share estimates were down 4% in the three months before earnings season, largely due to cyclical industries, the analysts say.
Financials have outperformed so far due to lowered expectations, and now, the analysts say, other cyclical sectors will likely follow that trend.
"In other words, the bar has been lowered into earnings season for cyclical pockets in particular, and stocks are being rewarded for clearing that lowered bar—Financials were the first example of this and groups such as Capital Goods and Consumer Services could follow," the analysts wrote on Monday.
They say the majority, or 92%, of large-cap banks that they cover, have beaten on operating earnings-per-share, and all of them have beaten on revenue so far.
As a result, financial stocks were the best-performing sector in the S&P 500 in the last two weeks, up 5.6% to outpace the overall index's 3% gain in that time.
Morgan Stanley had shifted to cyclicals and upgraded financials to overweight earlier this month due to a host of economic factors.
"Our upgrade of the sector in early October was based on accelerating capital markets activity, a 'de-risked' set-up into earnings season, as well as supportive relative valuation and positioning (among additional drivers)," the analysts said.