Small caps look vulnerable to higher interest rate – Morgan Stanley

Mike Wilson, Chief Investment Officer and Chief US Equity Strategist for Morgan Stanley, shares the outlook for investors about which sectors could benefit from an era of rising inflation and higher interest rates.

See – S&P 500 Index: Rising rates indicates a serious shift in market outlook – Morgan Stanley

Key quotes

“Now interest rates are finally catching up, and that is pushing down valuations faster than earnings revisions are moving up. This is very much in line with our call for this year: higher rates, lower valuations and strong earnings. What it means for investors is that 2021 is likely to be a year of modest returns for the major indices, but with massive dispersion between winners and losers.”

“Unsurprisingly, the best opportunities still reside in sectors that have been the most shut down over the past year. Areas like consumer and business services, travel and leisure, to name a few. It's also in sectors that are likely to benefit from higher interest rates or inflation, like banks, materials and energy. Small caps look a bit extended to us at the moment, and they could be vulnerable to higher interest rates, so we'd be a bit more inclined to add here on a further pullback.”

“The areas that appear most vulnerable to higher interest rates remain expensive growth stocks that have limited profitability at the moment. We're also wary of companies that may have experienced excess demand last year. This would include certain essential businesses that remained open during the pandemic and companies that produce goods and services required to work from home or provide entertainment during the lockdown.”