As earnings season kicks off this week, investors are largely expecting a slew of upgrades thanks to a turnaround in commodity prices
But this will be largely confined to resource companies. For industrials, excluding financials, investors are facing a continued downgrade cycle, meaning selecting specific stocks may be a better strategy than hitching onto a trend.
While many analysts are sceptical about an improving economic outlook for Australia, pointing to a slowing housing-linked sector and lagging consumer sentiment, Morgan Stanley says companies with earnings certainty are likely to receive buying support.
"Put simply, if companies show a first-half earnings split that compares favourably to prior years, we'd expect their stocks to be rewarded for added certainty," said James Bales, equity analyst at Morgan Stanley.
Companies such as Baby Bunting, which are positioned for a strong first-half result, are better placed than those who have guidance for the second half of the year, such as Automotive Holdings Group.
While the US dollar has roared higher following the US election in November, the firm expects an even further drop in the Australian dollar, to US65ยข by December. The team points to slowing global trade volumes and risks to China's growth story as the biggest weights on the Aussie.
"These forecasts imply similar double-digit declines against other major currencies," said Mr Blake. "The magnitude of such a move is too big to ignore."
As such, Morgan Stanley sees foreign earners and tourism-exposed stocks as the beneficiaries, such as Corporate Travel Management. While generally a weaker currency implies people would travel less, Morgan Stanley points to Corporate Travel Management's alignment to the business sector, which is unlikely to change the location or necessity of their trips.
Small caps may also begin to see some industry consolidation. A low-growth environment and the opportunity to build larger companies, either organically or via acquisition, could bring about a material re-rating.
Morgan Stanley points to Matra Group as a possible acquirer, given the hotel group has been adding rooms and increasing market share in 2016. A highly fragmented hotel market could pose consolidation opportunities.
That said, regulatory risk will weigh on small cap companies, says the firm. Aged care, radiology, car dealerships and China retailing have all suffered abrupt changes in regulation which has placed downward pressure on earnings.
"Regulatory changes are always occurring," said Mr Blake. "Following such an active year and with some outcomes yet to be finalised, we predict that this theme will remain important throughout 2017.