2021 is shaping up to be a year for stock picking. Here's how to play it

Published Sun, Mar 28 20219:00 AM EDTUpdated Sun, Mar 28 20219:13 AM EDT

The historic economic reopening is breathing life into areas of the market that once fell out of favor, setting up a long-awaited opportunity for stock pickers to shine. Top strategists from major Wall Street firms are advocating for active management as leadership moves down on the market-cap ladder and performance correlation among individual stocks comes down. "It's time to get active," Boris Lerner, quantitative strategist at Morgan Stanley, said in a recent note. "The current market environment, characterized by high stock specific risk, elevated return dispersion, and low correlation among stocks is supportive of active stock picking." Active long-only managers and long/short hedge funds tend to beat their respective benchmarks and generate higher returns amid these market conditions, according to Morgan Stanley. This year is shaping up to be a favorable one for active managers after Big Tech and stay-at-home players, which led the market's rebound and lifted the big benchmarks because of their size, pulled back. These high-growth stocks recently underperformed as rising interest rates erode the value of their future returns, making their lofty valuations harder to justify. Small caps have been outperforming this year with the Russell 2000 gaining 12%, versus the S & P 500 's near 6% return. Now as the market's fierce comeback rally took a breather, trading has turned choppier while there's been a higher disparity of stock performance, creating an environment where stock picking could add value. "The trading activity under the surface is significantly more uneven, suggesting that stock-pickers may be finding opportunities to generate even more alpha than passive index investors," said Chris Hussey, a managing director at Goldman Sachs. Idiosyncratic single stock opportunities Still, the chance for outperformance isn't equal across sectors for stock pickers. For example, the energy sector still has a high correlation among individual stocks, while the idiosyncratic risk and dispersion of returns is also low relative to history, Morgan Stanley noted. The Wall Street firm is recommending active managers to focus on real estate, health care and communication services stocks as they currently exhibiting high stock-specific risk, wide dispersion, and relatively low correlation compared to their historical patterns. Morgan Stanley highlighted a number of stocks for investors seeking more idiosyncratic single stock opportunities. These names have the highest stock-specific risk within their sectors, meaning they will react more sensitively to news related to their fundamentals. In the health care space, the bank listed Merck, Becton Dickinson and Eli Lilly. These stocks also all have an overweight rating at Morgan Stanley. Iron Mountain, Realty Income and Crown Castle Intl are Morgan Stanley's picks in real estate. The sector has rebounded 9% this year.

Traders work on the floor at the New York Stock Exchange.

Brendan McDermid | Reuters

The historic economic reopening is breathing life into areas of the market that once fell out of favor, setting up a long-awaited opportunity for stock pickers to shine.

Top strategists from major Wall Street firms are advocating for active management as leadership moves down on the market-cap ladder and performance correlation among individual stocks comes down.