AI adoption, dollar weakness and tax savings from the Big
Beautiful Bill are some of the factors boosting our CIO and Chief
U.S. Equity Strategist Mike Wilson’s confidence in U.S. stocks.
Read more insights from Morgan Stanley.
----- Transcript -----
Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan
Stanley’s CIO and Chief U.S. Equity Strategist. Today on the
podcast I will discuss what's driving my optimism on
stocks.
It's Tuesday, July 29th at 11:30am in New York.
So, let’s get after it.
Over the past few weeks, I have been leaning more toward our bull
case of 7200 for the S&P 500 by the middle of next year. This
view is largely based on a more resilient earnings and cash flow
backdrop than anticipated. The drivers are numerous and include
positive operating leverage, AI adoption, dollar weakness, cash
tax savings from the Big Beautiful Bill, and easy growth
comparisons and pent-up demand for many sectors in the
market.
While many are still focused on tariffs as a headwind to growth,
our analysis shows that tariff cost exposures for S&P 500
industry groups is fairly contained given the countries in scope
and the exemptions that are still in place from the USMCA.
Meanwhile, deals are being signed with our largest trading
partners like Japan and Europe that appear favorable to the
U.S.
Due to the lack of pricing power, the main area of risk in the
stock market from tariffs is consumer goods; and that’s why we
remain underweight that sector. However, the main tariff takeaway
for investors is that the rate of change on policy uncertainty
peaked in early April. This is the primary reason why earnings
guidance bottomed in April as evidenced by the significant
inflection higher in earnings revisions breadth—the key
fundamental factor that we have been focused on.
Of course, the near-term set up is not without risks. These
include still high long-term interest rates, tariff-related
inflation and potential margin pressure. As a result, a
correction is possible during the seasonally weak third quarter,
but pull-backs should be shallow and bought. In addition to the
growth tailwinds already cited, it’s worth pointing out that many
companies also face very easy growth comparisons.
I’ve had a long standing out of consensus view that the U.S. has
been experiencing a rolling recession for the last three years.
This fits with the fact that much of the soft economic data that
has been hovering in recession territory for much of that period
as well—things like purchasing manager indices, consumer
confidence, and the private labor market. It also aligns with my
long-standing view that government spending has helped to keep
the headline economic growth statistics strong, while much of the
private sector and many consumers have been crowded out by
that heavy spending which has also kept the Fed too
tight.
Meanwhile, private sector wage growth has been in a steady
decline over the last several years, and payroll growth across
Tech, Financials and Business Services has been negative – until
recently. Conversely, Government and Education/Health Services
payroll growth has been much stronger over this time horizon.
This type of wage growth and sluggish payroll growth in the
private sector is typical of an early cycle backdrop. It's a key
reason why operating leverage inflects in early cycle
environments, and margins expand. Our earnings model is picking
up on this underappreciated dynamic, and AI adoption is likely to
accelerate this phenomenon. In short, this is looking more and
more like an early cycle set up where leaner cost structures
drive positive operating leverage after an extended period of
wage growth consolidation.
Bottom line, the capitulatory price action and earnings estimate
cuts we saw in April of this year around Liberation Day
represented the end of a rolling recession that began in 2022.
Markets bottom on bad news and we are transitioning from that
rolling earnings recession backdrop to a rolling recovery
environment.
The combination of positive earnings and cash flow drivers with
the easy growth comparisons fostered by the rolling EPS recession
and the high probability of the Fed re-starting the cutting cycle
by the first quarter of next year should facilitate this
transition. The upward inflection we're seeing in earnings
revisions breadth confirms this process is well underway and
suggests returns for the average stock are likely to be strong
over the next 12-months.
In short, buy any dips that may occur in the seasonally weak
quarter of the year.
Thanks for tuning in; I hope you found it informative and useful.
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