Utility stocks could benefit from Biden's infrastructure push but investors should be wary of the energy sector, Morgan Stanley says

• Utility stocks are well-positioned to benefit from Joe Biden's infrastructure package, Morgan Stanley analysts said.
• Earnings normalization is likely to be the name of the game in the second half of the year.
• The infrastructure bill could disrupt earnings normalization, but would benefit utilities disproportionately.

Utility stocks are well-positioned to benefit from Joe Biden's infrastructure package but other factors could weigh on the energy sector, Morgan Stanley analysts wrote in a note on Monday.

Utilities would doubly benefit from Biden's infrastructure plan, analysts wrote. In absolute terms, additional funding for clean energy construction would directly boost bottom lines. And in relative terms, utilities' greater ability to pass along any corporate tax hikes used to fund infrastructure could help their stocks overperform.

Good news in energy stocks' earnings could begin to worsen in the second half, and even if it doesn't, much of it is already priced in, analysts wrote. While many observers have been bullish on energy stocks, Morgan Stanley's analysts emphasized that these assets remain risky, and downgraded them to underweight.

On the other hand, utility stocks' earnings have performed below the long-term average, indicating that normalization could drive share prices higher. A potential infrastructure bill could disrupt earnings normalization, but would benefit utilities disproportionately, analysts wrote.

Underpinning this outlook is a measure used in Morgan Stanley's quantitative model called earnings revision breadth, referring to the ratio of companies that adjust future profits upward versus downward. Surging earnings revision breadth often indicates forward-looking optimism for profits.

Earnings revision normalization is likely to be the name of the game in the second half of the year, the analysts wrote. Their case rests on key drivers of markets in the first half - including the post-pandemic reopening, stimulus checks, and the "crypto wealth effect" - abating as the economy returns to a semblance of normalcy.

An important dynamic of the current market cycle is that companies who beat earnings expectations match the market, whereas those who miss earnings are harshly published, analysts wrote. In the first quarter, companies that missed on earnings underperformed the market by 4.4%, but those that beat expectations only overperformed by 0.2% - another sign of most good news being priced in.