Which Sectors Will Lead The Markets Higher?

With stock market valuations down sharply, investors may be wondering whether this is a time to engage in bargain hunting. Noting that "multiples across the globe are well below 5-year averages," a recent report from Morgan Stanley says "we think it makes sense to start picking away at single stocks where valuations are depressed and/or earnings have been cut significantly."

Morgan Stanley's screening process found that the three sectors listed below offer the best potential opportunities right now.

3 Sectors That May Lead

• Consumer Discretionary
• Financials
• Industrials

^{Source: Morgan Stanley}

Significance For Investors

Morgan Stanley found 57 stocks that look particularly attractive right now on the basis of their valuations. The three favored sectors listed above contributed 34 of those 57 stocks, including SVB Financial Group (SIVB), Ameriprise Financial Inc. (AMP), and Synovus Financial Corp. (SNV) in financials; United Parcel Service Inc. (UPS) and United Rentals Inc. (URI) in industrials; and Mohawk Industries Inc. (MHK), Carnival Corp. (CCL), and Norwegian Cruise Line Holdings Ltd. (NCLH) in consumer discretionary.

"We took the S&P 1500 and looked at a blended normalized valuation over the last 5 years using a combination of forward price to earnings (25% weight), price to sales (25% weight), and price to book value (50% weight)," the report states. Morgan Stanley assigned a higher weight to the price to book value ratio because, in their opinion, it "is arguably a better indicator of value than income statement focused metrics" for stocks that are "deep cyclicals."

The 57 stocks on Morgan Stanley's list of attractive current valuations are those with market caps of at least $5 billion and "blended valuations" more than 1.5 standard deviations below their 5 year averages. More specifically, the report calls this a list of "stocks that may already be pricing a cyclical slowdown," and which "may offer opportunities for outperformance when the market finds a trough."

Looking Ahead

The report warns, "We aren't opining on whether or not the multiples are justified for each security on the lists," adding that "considerations beyond valuation matter." Meanwhile, Morgan Stanley also says: "We expect Cyclicals to lead the way once the market finally troughs. The recent relative strength of Cyclicals versus Defensives is supportive of our view that we are actually getting closer to a trough."

Whether or not the market actually does hit a low sometime in 2019 depends on various macro factors, most notably interest rate policy by the Federal Reserve and whether the economy keeps expanding, or slips into recession. Unresolved trade conflicts, in turn, continue to cloud the economic picture.