Morgan Stanley upgrades 'oversold' cyclicals

7th Oct 2014 09:04

Morgan Stanley has advised clients to increase their portfolio exposure to European cyclical stocks, upgrading the "oversold" industrials sector in particular.The bank said weaker growth now seemed to be increasingly priced into cyclical stocks, with forecast price-earnings (p/e) ratios at their lowest levels since late 2008.Since peaking on a relative basis in January, cyclical shares have underperformed the wider market by 6%, and are down 12% relative to defensive stocks.The earnings downgrades, which have hitherto weighed heavily on the sector, appear to have reached a trough, helped by the weakening in the euro.Morgan Stanley's economists also believe emerging-market demand has bottomed which should also benefit those in the sector with exposure."Cyclicals are just 4% off their 2011 lows relative to defensives," analysts wrote in a European strategy note. "While we may have to wait a little longer for evidence, we believe the growth outlook isn't as bad as feared."Financial conditions have eased considerably and economic surprise indices are not breaking down. While it is hard to see an imminent pick-up in growth, a broader slowdown is not our base case."Although forward p/e ratios appear attractive, other valuation metrics such as normalised p/e ratios are less supportive, and so analysts said they "remain selective" in buying cyclicals where there is greater conviction around earnings."In the event of a much more negative global growth environment than our economists anticipate, then this is still clear downside for cyclicals, but in our more pragmatic view, valuations of cyclicals look increasingly attractive at this juncture."In particular, many industrials look oversold, with attractive valuations and some areas showing an improvement in earnings momentum.As a result of the new thinking, London-listed Babcock is now a 'buy', along with Philips and BMW.