Rising Rates To Drive Bank Outperformance. Every Morgan Stanley strategist is overweight Banks (ex-Australia) and Financials. Makes sense, as banks are clear alpha generators when rates rise. In fact, in the US, banks and diversified financials are the only sector to have outperformed the S&P 500 when real rates rise. Our economics teams expect punchy inflation to persist into 2023, and our strategists are calling for real rates to rise this year. Coupled with high savings and rising wages, this suggests a very positive outlook for bank stocks. In addition, we expect lending will pick up. Consumer loan growth is driven by expectations for continued spending on housing and consumption as savings is burned down. Commercial loan growth is driven by a need to fund rising inventories. Unclogging the supply chain in this Covid Capex Cycle (see The Great Inventory Build) should drive above-trend C&I demand from countries that have historically been net importers. Structurally, C&I loan growth should increase from the global need to invest in green industries to hit COP26 goals, which Net Banking Zero Alliance estimates is a $100-150 Trillion investment requirement over next 30 years. In the US alone, banks' share of this should lead to a doubling of C&I loan growth over the medium term.

Be Nimble for Diversified Financials Opportunities. Payments have been under pressure given cross-border travel fears from recurrent Covid mutations, most recently Omicron.

Opportunities in the payment stocks as we expect a continued improvement in global travel over the next year as the world learns to live with these recurring waves of Covid mutations.

Additionally, the market underestimates the secular shift to cross-border eCommerce. For asset managers, we are more selective. Traditional asset managers face secular challenges as flows likely subside from record levels and fee rates continue to be under pressure. Brokers, on the other hand, should get a boost from higher rates, along with upside to achieving synergies from key acquisitions and expanded user bases. Likewise, Alts should continue to benefit from the secular demand for private market assets. Exchanges are more mixed, as we selectively prefer those geared to cyclical uplift from rates trading and those with secular growth exposure to fixed income electronification, indexing, analytics, and ESG.

Our most favored sectors include US Large Cap Banks & Consumer Finance, US Payments and Processing, Europe Banks, China Financials, India Financials, EEMEA Banks, Japan Banks, and S. Korea Financials.