Why the stock market's playbook for a Trump presidency will be completely different this time around

• Morgan Stanley said investors shouldn't bet on the same sectors that performed well during Trump's first term.
• Today, the economy is in a later cycle and not in a reflationary stage, the note said.
• Meanwhile, Trump's policy proposals are headwinds for small caps and low-quality stocks.

Donald Trump's 2016 win ignited fresh upside in some market sectors, but investors shouldn't bet on the same trades if he ends up in the White House next year, Morgan Stanley wrote on Monday.

Instead, a Trump victory in November would best serve high-quality stocks — not the small caps or low-quality cyclicals that outperformed eight years ago.

Despite this, investors took to the 2016 playbook last Friday, after the odds of a Republican White House grew to around 60% following the first presidential debate. That day, energy, financials, industrials, materials and small caps all beat the broader market, Morgan Stanley said.

However, analysts led by the bank's CIO, Michael Wilson, outlined three main reasons investors should rethink their strategy ahead of the election.

First, the US is further along in its economic cycle than it was during the 2016 election, based on a long decline in leading economic indicators, the analysts said. At this stage of the cycle, the market starts to focus on quality, moving away from small-cap cyclical names that outperformed during Trump's first presidency.

Analysts also suggested that this is worth paying attention to, irrespective of who wins the White House.

"[W]e think investors should stay selective within cyclicals regardless of the election outcome."

Second, Trump's last victory followed a downturn in 2015, which made investors eager to embrace a reflationary and pro-spending playbook. Friday's small-cap outperformance following the debate was driven by expectations that this would repeat under Trump, Morgan Stanley said.

Yet, that is the opposite of current economic conditions. Unlike 2016, investors today are focused on whether inflation and fiscal spending is going down.

Third, Trump's proposed policies will likely to weigh on growth, the bank said. That ranges from policy meant to deter and remove immigrants from the US, to Trump's plans for universal tariffs on all imports.

"Our Policy Strategists note that risks are skewed to the downside for growth under Republican win scenarios due in part to immigration reform and tariffs. These dynamics, in addition to a higher term premium, are likely headwinds to lower quality, cyclical areas of the market and small caps in this scenario," Wilson wrote.