Morgan Stanley Strategists Call Time on Early Reopening Winners

(Bloomberg) -- Strategists are rethinking which trades have room to run as euphoria over reflation gives way to more cautious markets.

A Morgan Stanley team in a note Wednesday said it was closing “early-cycle” recommendations, such as trades in favor of copper versus gold, the Canadian dollar versus the Swiss franc and small caps against their larger peers. The strategists reduced a government bond underweight to 2% from 4%.

“The next phase of the cycle remains broadly supportive of risk assets, but less so than before,” the team led by Andrew Sheets wrote. Fiscal stimulus and falling virus hospitalization rates are helping the outlook but the upward economic cycle could be shorter than before as it’s running hotter.

The shift in the stance comes as markets mark one year since the pandemic-fueled meltdown. Global stocks are up more than 70% from their lows and 10-year Treasury yields have risen to about 1.6%. But so-called reopening and reflation trades tied to the recovery from the health crisis took a pause this week, most notably a sharp slide in crude oil.

The bond market selloff has been the key area of focus this year, with 10-year U.S. Treasury yields touching 1.75% earlier this month. The push higher in long-term borrowing costs rippled across assets.

“Higher yields are sometimes portrayed as a pure negative for the market and they’re not,” Sheets said in a recent interview. “They can help the economics for pensions, insurance companies and banks. I feel pretty confident that the Treasury market will continue to find buyers as yields move higher.”

Trimming Allocations

There are hints of caution among other commentators about consensus recovery plays. For instance, UBS Global Wealth Management strategists including Solita Marcelli still lean toward some small and mid-cap stocks tied to the economic recovery, but “recommend trimming allocations that may have drifted far above” benchmarks.

Nothing is really “cheap” anymore, and while flows will continue to head into cyclical stocks, the latter “will have to prove that their peak earnings power is undamaged if not actually better than before,” Nicholas Colas, co-founder of DataTrek Research, wrote in a note.

A shift to value investing has overlapped with the move to cyclicals this year. Most of the value rally may be over, according to Scott Berg, global equities portfolio manager at T. Rowe Price.

“My best guesstimate is we’re 75% to 80% of the way through,” he said in a presentation Wednesday. “I’m now actively trimming the value we inserted into the portfolio a year ago.”

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