Morgan Stanley warns about an 'uncertain macro backdrop'

The US economy continues to send mixed signals, leading to recent swings in both stock and bond markets.

In a recent note, Morgan Stanley strategists indicated that the market is expected to fluctuate between pricing in "soft landing" and "no landing" scenarios in the current late-cycle environment.

They believe that the continuation of mixed macroeconomic data will drive this back-and-forth, with last week's market activity serving as a clear reflection of this oscillation.

Specifically, the Employment Cost Index data and the price components of the ISM Manufacturing and Services indices were stronger than expected. In contrast to the latest, Nonfarm Payroll (NFP) report, the Conference Board Consumer Confidence index, and the overall ISM readings, all of which came in below expectations.

“In our view, this uncertain backdrop warrants an investment approach that can work as market pricing and sector/factor leadership bounces between these potential outcomes— we recommend a barbell of quality cyclicals (which we see outperforming in a "no landing" scenario) and quality growth (the relative winner in a "soft landing" backdrop, in our view), Morgan Stanley’s strategists wrote.

The latest Federal Open Market Committee (FOMC) meeting unfolded largely as expected, the Wall Street giant said, with Chair Powell expressing reduced confidence in the timing of the first rate cut due to recent inflation data but firmly dismissing the prospect of an imminent hike.

Markets will now focus on the April consumer price index (CPI) report on May 15, which will be crucial for monetary policy guidance.

Meanwhile, the consumption landscape appears divided, with stable high-end spending and weaker low-end activity.

As lower-income consumers scale back and seek cheaper alternatives, companies emphasize "value." Morgan Stanley highlighted that mentions of "value" in Consumer Discretionary earnings calls are historically high, with post-report stock performance (0.2%) aligning with the sector average (0.3%).

“We see Consumer Staples as a beneficiary of trade down from discretionary categories. On this score, the relative earnings revisions of Consumer Staples vs. Consumer Discretionary have recently turned higher, pointing to upside in relative performance from here,” said strategists.

“We think Staples over Discretionary makes sense in this context and in today's later cycle environment,” they added.