Our CIO and Chief U.S. Equity Strategist Mike Wilson
explains why he continues to hold on to an out-of-consensus view
of a growth positive 2026, despite near-term risks.
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 I’ll discuss our outlook for 2026 that we published earlier
this week.
It’s Wednesday, Nov 19th at 6:30 am in New York.
So, let’s get after it.
2026 is a continuation of the story we have been telling for the
past year.
Looking back to a year ago, our U.S. equity outlook was for a
challenging first half, followed by a strong second half. At the
time of publication, this was an out of consensus stance. Many
expected a strong first half, as President Trump took office for
his second term. And then a more challenging second half due to
the return of inflation.
We based our differentiated view on the notion that policy
sequencing in the new Trump administration would intentionally be
growth negative to start. We likened the strategy to a new CEO
choosing to ‘kitchen sink’ the results in an effort to clear the
decks for a new growth positive strategy. We thought that
transition would come around mid-year.
The U.S. economy had much less slack when President Trump took
office the second time, compared to the first time he came into
office. And this was the main reason we thought it was likely to
be sequenced differently. Earnings revisions breadth and other
cyclical indicators were also in a phase of deceleration at the
end of 2024. In contrast, at the beginning of 2017—when we were
out of consensus bullish—earnings revisions breadth and many
cyclical gauges were starting to reaccelerate after the
manufacturing and commodity downturn of 2015/2016.
Looking back on this year, this cadence of policy sequencing did
broadly play out—it just happened faster and more dramatically
than we expected. Our views on the policy front still appear to
be out of consensus. Many industry watchers are questioning
whether policies enacted this year will ultimately lead to better
growth going forward, especially for the average stock. From our
perspective, the policy choices being made are growth positive
for 2026 and are largely in line with our ‘run it hot’
thesis.
There’s another factor embedded in our more constructive take.
April marked the end of a rolling recession that began three
years prior. The final stages were a recession in government
thanks to DOGE, a rate of change trough in expectations around AI
CapEx growth and trade policy, and a recession in consumer
services that is still ongoing. In short, we believe a new bull
market and rolling recovery began in April which means
it’s still early days, and not obvious—especially for many
lagging parts of the economy and market. That is the
opportunity.
The missing ingredient for the typical broadening in stock
performance that happens in a new business cycle is rate cuts.
Normally, the Fed would have cut rates more in this type of
weakening labor market. But due to the imbalances and distortions
of the COVID cycle, we think the Fed is later than normal in
easing policy, and that has held back the full rotation toward
early cycle winners.
Ironically, the government shutdown has weakened the economy
further, but has also delayed Fed action due to the lack of labor
data releases. This is a near-term risk to our bullish 12-month
forecasts should delays in the data continue, or lagging labor
releases do not corroborate the recent weakness in
non-govt-related jobs data.
In our view, this type of labor market weakness coupled with the
administration's desire to ‘run it hot’ means that, ultimately,
the Fed is likely to deliver more dovish policy than the market
currently expects. It's really just a question of timing. But
that is a near-term risk for equity markets and why many stocks
have been weaker recently.
In short, we believe a new bull market began in April with the
end of a rolling recession and bear market. Remember the S&P
[500] was down 20 percent and the average S&P stock was down
more than 30 percent into April.
This narrative remains underappreciated, and we think there is
significant upside in earnings over the next year as the recovery
broadens and operating leverage returns with better volumes and
pricing in many parts of the economy. Our forecasts reflect this
upside to earnings which is another reason why many stocks are
not as expensive as they appear despite our acknowledgement that
some areas of the market may appear somewhat frothy.
For the S&P 500, our 12-month target is now 7800 which
assumes 17 percent earnings growth next year and a very modest
contraction in valuation from today’s levels. Our favorite
sectors include Financials, Industrials, and Healthcare. We are
also upgrading Consumer Discretionary to overweight and prefer
Goods over Services for the first time since 2021.
Another relative trade we like is Software over Semiconductors
given the extreme relative underperformance of that pair and
positioning at this point. Finally, we like small caps over large
for the first time since March 2021, as the early cycle
broadening in earnings combined with a more accommodative Fed
provides the backdrop we have been patiently waiting for.
We hope you enjoy our detailed report published earlier this week
and find it helpful as you navigate a changing marketplace on
many levels.
Thanks for tuning in. Let us know what you think by leaving us a
review. And if you find Thoughts on the Market worthwhile, tell a
friend or colleague to try it out!
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