Morgan Stanley: Don’t chase low quality, large caps offer more compelling risk/reward

In a note to clients Monday, Morgan Stanley analysts advised investors against chasing low-quality trades and said that large caps offer a more compelling risk/reward ratio.

Economic releases are busy over the next two weeks, with ISMs, payrolls, CPI, and the FOMC meeting all set to take place.

Morgan Stanley notes that both stocks and bonds oscillated around Fed speak and macro data releases last week as equities held key technical levels.

“We highlight that the bond yield versus equity return correlation has fallen further into negative territory over the last several weeks,” they wrote. “It’s now at a 5-month low for large caps and a 9-month low for small caps.”

“While small caps are showing greater rate sensitivity (a -0.6 correlation to rates vs. -0.3 for large caps), we view this dynamic as being somewhat asymmetric,” they said, adding that higher rates are clearly a relative headwind for small caps.

“That said, we’re not convinced lower rates offer a comparable benefit unless they are sustained for an extended period of time and accompanied by stronger growth/pricing power,” argues the bank.

Overall, while they are respectful of light positioning in small caps, Morgan Stanley continues to see large caps offering a “more compelling risk/reward” over the next several months.