Mike Wilson, our CIO and Chief U.S. Equity Strategist, and Dan
Skelly, Senior Investment Strategist at Morgan Stanley Wealth
Management, discuss the outlook for the U.S. stock market in 2026
and the most significant themes for retail investors.
Read more insights from Morgan Stanley.
----- Transcript -----
Mike Wilson: Welcome to Thoughts on the
Market. I'm Mike Wilson. Morgan Stanley’s CIO and Chief U.S.
Equity Strategist.
Daniel Skelly: And I'm Dan Skelly, Senior
Investment Strategist for Morgan Stanley Wealth Management.
Mike Wilson: Today we're going to have a
conversation about our views on the U.S. stock market in 2026,
and what matters most to retail investors in particular.
It's Monday, December 8th at 9am in New York.
So, let's get after it.
Dan, it's great to see you. We always talk about the markets
together. I think this is a great opportunity for us to share
those thoughts with listeners.
Our view coming into this year is still pretty bullish for 2026.
We've been bullish on [20]25 as you have, probably for, you know,
similar – maybe some slightly different reasons. I think one of
our differentiating views is that we do think inflation is still
a major risk for individual investors. And institutional
investors, quite frankly, which is why stocks have done so much
better. A concept, I think you're well aware of.
And I think, you know, the risk for retail is that there's going
to be; it's going to be volatile. So, point-to-point, we're still
bullish as you are. How are you thinking about managing that
point-to-point path? And how are you structuring your portfolio
as we go into 2026 with a bullish outlook – but understanding
that it's not always going to be smooth.
Daniel Skelly: So, like you said, we've
also shared this view that next year's going to be positive,
albeit there's going to be more volatility. And when I think
about the two main risks that retail investors are facing today,
one of them is definitely inflation.
We're seeing that in services. We're seeing that in housing.
We've had the labor market shrink over the recent couple of
quarters, so who knows if wage inflation pops up again. But there
are ways to definitely hedge against that in an equity portfolio.
We think, for instance, owning parts of the AI infrastructure
cohort is one of the ways of hedging, whether that be in
utilities, pipelines, energy infrastructure in general. These are
areas that we think are a necessary hedge against inflation risk.
And number two are a positive diversifier.
And second key point, Mike, just thinking about that
diversification comment. Look, we all know that in many ways the
Mag 7 – and the technology strength that we've seen this past
year – has driven a fairly concentrated market. I think what
people, particularly on the individual side, are recognizing less
is just how much AI cuts across many other sectors in parts of
the market. And again, we think that risk of over concentration
is still out there. And we like the idea of thinking of embedding
natural diversification into the equity portfolio.
Mike Wilson: Yeah. I mean, it's
interesting. Inflation, you know, is part of that story too
because AI is somewhat disinflationary or deflationary. I think,
you know, investing in things that can drive higher productivity
even away from AI can mitigate some of that risk in the economic
outlook. But if I think about, you know, the Mag 7 dominance, and
just this concentrated market risk, which you spoke about. If
inflation re-accelerates next year, which, you know, is one of
our core views as the economy improves – doesn't that broaden out
the opportunity set?
And you know, like there's been this idea that, ‘Oh, you have to
own these seven stocks and nothing else.’ I mean, part of our
view for next year is that we think the market's going to broaden
out. How are you set up for that broadening out? And how are you
thinking about picking stocks and new themes that can work – that
maybe people aren't paying attention to right now?
Daniel Skelly: Yeah, it's a great point,
Mike. And so, on the first topic, we do think there's broadening,
and that's a combination of factors. Number one is just the
market becoming more convicted about the Fed cutting path, which
we've talked about, and the firm's view reaffirms for next year.
Number two is starting to see some of the benefits of
deregulation, right, which should impact maybe some of the more
cyclical sectors out there – Financials, Energy being two of
them.
Maybe seeing more M&A activity too as a byproduct of
deregulation. And that should bode better for mid- and maybe
small caps as well as they receive a M&A premia in the
valuations. And I know you've talked about small caps recently in
your commentary.
But last point I'll make Mike, and it comes back to AI. It almost
feels like AI is this huge inflationary ramp at first to get to
that deflationary nirvana down the road – with productivity. I
think one of the key factors we think about, in terms of a
bottom-up perspective, which is what we focus on in across the
portfolio, is definitely pricing power. Who owns the pricing
power and the key data and the key AI adoption outlook in order
to absorb all the different tools and technology diffusion we've
seen in the last three years.
And that's going to play out, Mike, as you well know, across a
variety of sectors and themes. So, agreed, we should see
broadening for all those varying reasons.
Mike Wilson: So, I mean, there are a couple
areas I think, where we overlap. Financials…
Daniel Skelly: Yep.
Mike Wilson: Industrials, Healthcare, some
of the themes that I think we both; we share our bullish views.
And what do you think those areas are, within those sectors? You
think that you have a differentiated view maybe than the
consensus being Financials, Industrials, Healthcare? That the
market may be missing, which offers more upset?
Daniel Skelly: Sure. I'll start with
Financials, which has been an overweight call for us for some
time, as I know it has for you as well. And I think that kind of
cyclical re-acceleration in the economy is one part. I think the
Fed cutting is another part. I think deregulation is clearly
another driver. Fourth Capital Markets recovery, which we have
seen now. We had a little bit of a technical lull with the
government shutdown in terms of filings and issuance, but we see
all of the pipeline indicators, indicating green lights for next
year in terms of recovery.
I think the one thing I would argue that I've observed in looking
at all of our vast data sets is that despite all these different
bullish factors, this still maybe has been a theme or a sector
that investors have traded in and out of, right? I don't think
I've even seen like a real strong, consistent overweight. So, I
think number one, that's an opportunity. And last point is,
listen, there's different sub-sector bifurcation going on, as you
know, within the industry, whereas money centers and large banks
are performing really well.
The same is not the case of regionals and alts managers. And
there are varying reasons for that. But we would even argue,
Mike, there could be catchup trades within the sector next
year.
Mike Wilson: Yeah, I would agree on that. I
mean, the regional over money centers and actually regionals over
alt managers, because I mean – I think the Treasury Secretary has
talked about this, you know. Trying to get the regulated banking
system kind of back in the game may actually be an opportunity to
take share back from some of those alt managers, which have
actually done quite well.
What about on Healthcare? We upgraded that back in the summer. I
think you've been constructive on parts of Healthcare, right.
Wwhat do you think people are missing there and why could that be
a good sector for next year?
Daniel Skelly: Yeah. We were definitely,
I'll say, earlier than you and wrong. You had really good timing
in terms of your Healthcare upgrade last summer. And look, the
sector was out of favor for two years. What we think we observed
in the kind of July-August period is: First and foremost, I think
we got past the point of maximum policy concern and risk. And
ironically, we saw some kind of nominal or surface level deal
signed with the government around most favored nation pricing.
And it was really, not a lot to write home about.
It wasn't as egregious as a policy inflection as some had feared.
So, I think that was the first key catalyst.
Second, we just saw a really good revisions breadth. And I know
this is a comment you make a lot in your work. But we saw across
big pharma, tools and life science, medical technology, and
devices. We saw really good positive earnings revisions coming
out of third and even starting the second quarter. Thirdly, I
think if you're talking about an M&A in capital markets
recovery, you can't not talk about Healthcare. I think that's a
space that'll be ripe for deal making.
And then just fourth, right? Look, as the market broadens out,
and as people are stopping or maybe slowing the crowding and the
key leadership, they're going to go again from AI enablers to AI
adopters. And we think AI is going to be a vector that cuts
across the Healthcare industry in a really positive way.
Mike Wilson: Yeah, I mean, the efficiencies
that are, you know, possible in the Healthcare sector seem
immense. I mean, it, it appears to me that that's going to be an
area where there's probably some new solutions, some new
companies we don't even know about yet. So, to me that's a very
exciting area that's been dormant for quite a while.
What about Consumer, Dan? It's been this K economy. It's been
very bifurcated, you know, high-end versus middle-income,
lower-income. I mean, what are the themes within consumer that
you're finding in putting to work in your portfolio?
Daniel Skelly: Yeah. We've talked a lot,
Mike, in the last year or so about playing Consumer platforms,
particularly domestically oriented versus global consumer brands.
And there's a couple of key drivers behind that.
But first, when you look at what's going on in consumer land, and
Simeon Gutman's been a really good, kind of, analyst looking at
this theme over time. In many ways it's starting to resemble the
Mag 7 in terms of winner take all phenomena. If you look at some
of the major consumer big box platforms, they're taking 50- 60
percent of share of total retail sales. Just a couple of
companies.
So, number one, we're really focused on platforms where market
share gains, free cash flow and revenue – recurring revenue – in
particular, are leading to even stronger competitive moats,
particularly in a capital-intensive industry. And what we've
observed about retail is that as those leaders in big box areas
take more share, they can reinvest that winning capital in their
advertising growth in their online channel and widen their moats
even more.
Secondly though, in order to have a positive theme, I've always
said you got to fund it from somewhere. And so, what we've
observed again over the last year or so is – when I think about
some of the even highest quality global brands they've suffered
seeing less traction in China. And that's amid less of a
willingness from Chinese consumers to own American and European
brands. There's a lot to that, but I think culturally, obviously
the trade war, the AI war for prominence
leading to maybe some of that lack of cultural traction.
Secondly, we've also, I think, started to see the growth of AI
tools start to weigh on established brands. I think what makes a
brand cool and the barriers to entry in terms of creating brands
is going to go down in the future because of AI influencing and
advertising tools. And so, simply put, we continue to like, Mike,
the big box consumer platforms across, clothing and food,
housing, across e-commerce.
That continues to be one of our higher conviction themes.
Mike Wilson: All right, Dan, I want to come
back to, kind of, AI infrastructure. I mean, AI spending has been
the big, big theme. But there's other types of infrastructure
spend and CapEx. It's been dormant, quite frankly, and with the
[One] Big Beautiful Bill [Act] perhaps incentivizing some of
that. How does that play into your thought process around other
industrial stocks that could benefit?
Daniel Skelly: Absolutely, Mike. You cited
the AI infrastructure spending. We think continues kind of
unimpeded going into next year. Number two, we think the Fed
cutting, just creating better financing conditions in terms of
bigger projects. You mentioned as well, the fiscal incentives.
And look, I think Chris Snyder has been spot on the last year or
so talking about reshoring production wins coming back to the
U.S. I don't think this is certainly as cognizant on the – or on
the minds of individual investors. Maybe not even institutional
investors. But the U.S. is winning manufacturing production share
and has been for some time.
And we've seen that no doubt ramp up post the announcement of the
[One] Big Beautiful Bill {Act]. No doubt. But we think that has
implications, Mike, for stocks and stock picking within what we
would call, kind of, shorter cycle themes. And I think whether
that be in Logistics and Transports or HVAC or some of the
Non-Resi, Non-Datacenter related verticals. There are a whole
bunch of stocks that have been kind of dormant for two to three
years as we've been in this ISM recession that we think could
certainly wake up next year as things broaden out.
Mike Wilson: Yeah, we would agree with
that. And I guess lastly, you know, there's always this Johnny
come lately, you know, fear factor of, ‘Well … stocks are up a
ton. My neighbor's bragging how much money they're making. So, I
must have missed it all.’ And I think embedded within that is
this fear of valuation. The valuations are now very rich. What's
your response to individual clients about – it's not too late,
they haven't missed it. It's still a bull market.
In fact, we would argue a new bull market began in April with a
new economic cycle. What is your response to those folks who
have that angst?
Daniel Skelly: Two things. One is the
market today looks totally different than it did in the past, and
AI is no doubt one big part of that. The composition of the
market in many ways is higher quality, less debt, more recurring
revenue. Big call option on productivity coming from AI earnings,
power, et cetera. So, we think the market should trade at richer
levels than it did in the past, point number one.
Point number two, we would say whereas most people say time is
your friend – for individual investors, they would also say
valuation is no short term or short run indicator, but it's the
best long run indicator. And looking at today's, again, extended
levels of valuation relative to history – they would say that's
not going to play out well over the long run.
I would actually take the other side of that. I think that the
earnings and the economic potential unleashed not just from AI,
but some of these fiscal and monetary policies could create
tremendous margin earnings potential in the long run.
And so, I think today we're looking at a level of multiples that
appears artificially high. And based on what could be a big
earnings inflection point in that multi-year timeframe could
frankly just be superficially high.
Mike Wilson: Well, Dan, it's always great
to get your perspective. I always enjoyed chatting with
you.
Daniel Skelly: Likewise.
Mike Wilson: Thanks for coming on the show
and sharing it with our listeners. It's great to see you.
Daniel Skelly: Thanks Mike.
Mike Wilson: And thanks to our listeners.
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