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Morgan Stanley says glum profit view to dent economy-tied stocks

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A dimmer outlook for U.S. corporate earnings is likely to hurt stocks that are tied to the economy, as investors worry about the impact of falling inflation on pricing power, according to Morgan Stanley’s Michael Wilson.

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“In our view, this does not offer support for a broad cyclical rotation,” Wilson said, adding that the market was “also potentially focused on the notion that falling inflation may prove to be a headwind for cyclicals, which are highly dependent on pricing power.” A Citigroup Inc. basket shows earnings downgrades have broadly outnumbered upgrades since late June. Meanwhile, cyclical stocks in the S&P 500 have underperformed the relatively safer defensive sectors since April.

“For now, we continue to think the better risk/reward within small caps is growth equities, which should benefit from a cost of capital standpoint as the Fed cuts” rates, Wilson said.

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