Stocks that are sensitive to the economy, or "cyclical," are beaten down -- and look attractive.
Selectivity is key.
If the economy continues to grow, cyclicals will see earnings growth, but economic growth likely won't accelerate, given that the Federal Reserve isn't about to cut interest rates. U.S. real gross domestic product growth has hummed in the low single digits this year, below the boom years of the early 2020s. Owning higher-quality cyclicals is a way to buy into the sector, while doing some hedging against the risk of a recession, which would devastate lower-quality names.
"We have been in the quality camp," says CIBC Capital Markets' head of equity and portfolio strategy, Chris Harvey, who particularly likes industrial cyclicals right now.
Quality means an asset has a higher predictability of cash flows and a low likelihood of failing to produce cash. For stocks, this means different combinations of the following: high profit margins, consistent pricing power, relatively small fluctuations of earnings, and strong balance sheets with minimal debt.
So Morgan Stanley's chief U.S. equity strategist Mike Wilson screened for quality stocks. To make the screen, a company had to land in the top 1,000 in the U.S. by market capitalization, the top quartile of Morgan Stanley's statistical score of quality, have higher earnings estimates from analysts over the last three months, and have an Overweight rating from the analyst at the bank that covers the stock.
The rather cyclical companies on Wilson's screen are beaten down, appear cheaper, and will grow profits as long as the economy continues to grow moderately. Typical cyclical sectors are manufacturers, which benefit from more corporate investment in equipment and materials, financials, which benefit from stronger demand for capital and higher asset prices, and consumer discretionary, which would benefit from growing consumer spending.
The high-quality cyclicals on Wilson's screen that are down at least a few percent from highs: Sherwin-Williams, Booking Holdings, Kate Spade-owner Tapestry, Wells Fargo, manufacturers Trane Technologies, Johnson Controls International, Vertiv Holdings, industrial distributor Ferguson Enterprises, and chemicals maker Ecolab.
Sherwin-Williams looks interesting. Down roughly 15% from its late 2024 record high, it has dropped along with housing-exposed stocks, which have fallen victim to climbing rates. Sherwin now trades at about 25 times next 12 months earnings, below the midpoint of its range in the past two years, with the peak at over 30 times.
Now, earnings growth can take shares higher, especially if the rate damage is over. Treasury yields surged in September to reflect inflation, but have now gone nowhere for about a month. Much of the inflation is already reflected in Treasury yields, so the stock has already reflected a lot of the economic risk, setting the stage for gradual gains on the back of modestly rising earnings.
Sherwin is positioned to nudge earnings higher. It has built a firm foundation in paints and coatings, has often increased prices, has grown sales every year since at least 2012 to $23.6 billion in 2025, and usually doesn't disappoint, having beaten earnings estimates in 14 of the past 20 quarters.
Analysts expect 4.5% annual revenue growth for the coming two years, according to FactSet. That, combined with operating cost discipline, can increase profit margins. Add in share repurchases, which decreases the share count, and analysts model 11% annual earnings per share growth over the coming two years.
Some of these "old economy stocks" could make an investor new money.
Comments