- The US stock market is eyeing a "no landing" scenario for the US economy, Morgan Stanley says.
- In that scenario, the US sees high economic growth and sticky inflation.
- The outperformance of cyclical sectors like energy and materials suggests leadership is beginning to broaden.
The stock market is looking past the soft versus hard landing debate and is getting comfortable with the idea of no landing at all for the US economy, Morgan Stanley says.
In a note to clients on Monday, Morgan Stanley's Michael Wilson and his team said that investors have abandoned the "soft landing" view, which seemed probable a few months ago. In that scenario, inflation would continue to come down, and the US would enter into a short, shallow recession.
That view has been complicated by a string of upbeat data, though. March saw US unemployment drop to 3.8%, accompanied by a strong reading of the ISM manufacturing index and a 2.5% increase in annual Personal Consumption Expenditures, which is the Federal Reserve's preferred measure of inflation.
"[T]he macro data and equity market leadership have started to support the no landing outcome with recent growth data points exceeding most forecasters' expectations and inflation data remaining a bit stickier than expected," he wrote in the note.
Wilson highlighted broadening leadership in the stock market, exemplified by the outperformance of cyclical sectors like energy and materials so far this year, saying this supports the notion that "the equity market is beginning to process a better growth environment."
Leadership diversifying in the stock market sharply contrasts with the tech-heavy surge fueled by artificial intelligence last year, but Wilson cautioned that while cyclically sensitive stocks and sectors are gaining momentum, maintaining quality is essential.
"We think this combination of quality and cyclical factors makes sense in the context of what is still a later cycle rather than an early cycle reacceleration in growth," he said, adding that if the latter scenario were true, investors would witness a sustained outperformance of low-quality cyclicals and small caps.
The equity market has been on a roller coaster as it reacts to developments in the macro environment. Over the past year, consensus views have whipsawed back and forth between expectations for a soft or hard landing.
The strategists also emphasized the significance of the 10-year US Treasury yield as a key indicator of market sensitivity to macroeconomic conditions, saying that small caps and low-quality stocks show more sensitivity to rate changes compared to large caps.
"While rate sensitivity would likely increase more broadly if we were to see a sustainable move above 4.35-4.40 on the 10-year, we would still expect large cap, quality equities to outperform on a relative basis," they added.