Lisa Shalett believes that the profitability issues of small-cap stocks are unlikely to be resolved by a 75 basis point rate cut by the Federal Reserve. The prospect of the Republican Party winning in the November election in the United States may stimulate the small-cap stock market, but this market is expected to be short-lived. Sustainable fund rotation favors large-cap stocks and high-quality cyclical stocks
Lisa Shalett, Chief Investment Officer of Morgan Stanley Wealth Management, stated in a recent report on Monday that as traders anticipate the Federal Reserve to cut interest rates later this year, funds are flowing out of US tech giants and into some underperforming stocks. This trend appears to continue, but the fundamentals do not support chasing after gains in US small-cap stocks.
Shalett warned against chasing small-cap stocks as their upward momentum may not be sustainable. The lagging impact of rate cuts and the prevalence of unprofitable companies in small-cap indices make these stocks lack tailwinds. The earnings issues within this group are unlikely to be resolved by a 75 basis point rate cut. The prospect of a Republican victory in the November elections may spark a rally in small-cap stocks, but this rally is expected to be short-lived.
Regarding the rotation of US stock styles, Shalett believes it is sustainable, supported by rate cut expectations, steepening yield curve, weakening US dollar, and profit growth expanding beyond the "FANG" stocks. "In summary, we prefer the resilience of large-cap stocks over small-cap stocks."
Specifically, large-cap stocks and quality cyclical stocks are Morgan Stanley's top choices, including financials, energy, industrials, aerospace/defense, some power grid infrastructure, residential real estate investment trusts (REITs).
Shalett's avoidance of small-cap stocks aligns with her colleague, Morgan Stanley strategist Michael Wilson. Earlier this month, Wilson advised investors to remain cautious and opt for quality US stocks over small-cap stocks as the US election season approaches.
On Monday, following three consecutive days of selling, funds once again rotated into US small-cap stocks, with the S&P 500 rising over 1% and the small-cap Russell 2000 index gaining 1.7%