Since the recent presidential debate, former President Trump's odds of winning the 2024 election have ticked higher, as reflected in both polls and odds markets. As a result, investors are now asking questions about how to position for this potential outcome.
Weighing in on this matter, Morgan Stanley analysts said they are more focused on the business cycle rather than the election outcome, as they did in 2016-2017.
"While markets have been digesting the rising odds of a Trump win, cyclical upside from here will likely be dependent on growth, in our view,” they said in a note.
They highlight that the current later cycle environment continues to support quality investments. Within cyclicals, analysts favor large-cap Industrials due to their recent relative performance strength and undemanding relative valuation levels.
They also point to recent positive inflections in industrial production growth and the industrial economic surprise series as supportive of the group's relative performance.
"In our view, the combination of the soft CPI print on July 11th and the rise in the odds of a Trump win from July 12-15 catalyzed a positioning-driven rotation toward small caps, fueled in part by dealer demand and short covering,” Morgan Stanley’s team continued.
However, analysts remain skeptical about the durability of small-cap outperformance, noting that the group has historically underperformed following tactical rallies and is now facing technical resistance.
For those considering the 2016 playbook, analysts explained that relative earnings revisions for small-cap cyclicals are much weaker today than during that period.
"We would be looking for a clear reacceleration in small cap earnings revisions coupled with strength in business cycle surveys focused on small businesses. For now within small caps, we believe growth equities offer the better risk-reward."
Analysts added that small-cap valuations stand to benefit as the Fed initiates its rate-cutting cycle, but at the same time, their revenue streams are not as severely exposed to the falling pricing power that enables those cuts.