Morgan Stanley says the catch-up trade in energy can continue and names its top picks to play

Oil stocks are finally playing catch up as the energy sector has become one of the best performing sectors of the market this year, according to Morgan Stanley. "An improving macro backdrop has started a catch-up trade for Energy," analyst Devin McDermott told clients in a research note Thursday. The sector lagged the broader market last year as crude sagged, but is now following oil prices higher.

Energy is also comparatively cheap, trading two times lower than its historical valuation vs. the S & P 500. The sector offers free cash flow and shareholder return yields that are as much as three times higher than the broader market, McDermott told clients. The analyst raised price targets for Morgan Stanley's coverage by a median of 3%. He is recommending quality trades such as ConocoPhillips , Occidental , Diamondback and Devon .

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Morgan Stanley upgrades the energy sector, citing ‘compelling valuation''We continue to believe we're in a late cycle market environment, which has historically been supportive of Energy outperformance,' Michael Wilson wrote.
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