Stick with quality growth, says Morgan Stanley

Morgan Stanley’s chief U.S. equity strategist told investors in a note Monday to “stick with quality growth.”

Analysts, who are reportedly stepping down from their roles as chair of the firm’s Global Investment Committee, explained that last week’s better economic data and mixed earnings resulted in further narrowness and strong performance from large-cap quality growth — the bank’s preferred pocket of the equity market.

“We’re encouraged by quality growth’s relative strength last week even as rates pushed higher on Friday,” they wrote. “We see a relative performance catch up to strong relative earnings revisions and note that the cohort can outperform in all three macro scenarios we have laid out for 2024.”

Analysts also noted that small caps appear to now be exhibiting greater interest rate sensitivity than large caps.

“As we’ve discussed in the past, small caps are particularly economically sensitive and reliant on pricing power,” they said. “As they await more definitive confirmation on whether a higher nominal growth environment is coming, small caps are being weighed down by a weakening margin profile and higher leverage.”

“The latter is likely one reason why the correlation between rates and returns remains negative for small caps, diverging from the correlation between rates and returns for large caps, which is now modestly positive—i.e., small caps appear to now be exhibiting greater interest rate sensitivity than large caps.”

Analysts went on to state that their firm finds that 4Q beat rates alone have been “fairly insignificant” in terms of explaining price reactions to earnings reports.