Morgan Stanley says the equity market is entering a stronger phase than most investors realize, despite the recent pullback.
In a new episode of the Thoughts on the Market podcast, Morgan Stanley CIO Mike Wilson says labor market softness could force the Fed to take a more accommodative stance that could alter the S&P 500’s direction.
“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.”
Wilson believes that the market already escaped its rolling recession earlier this year, setting the stage for a broader earnings recovery and the early innings of a new cycle.
“In short, we believe a new bull market began in April with the end of the rolling recession and bear market. Remember, the S&P was down 20% and the average S&P stock was down more than 30% into April. This narrative remains underappreciated, and we think there’s significant upside in earnings over the next year as the recovery broadens.”
He also predicts that firms will see meaningful earnings upside next year, along with operating leverage returns with better volumes and pricing. Under those conditions, Wilson expects the S&P500 to soar to new record highs in the coming months.
“Our forecasts reflect this upside to earnings, which is another reason why many stocks are not as expensive as they appear, despite our acknowledgment that some areas of the market may appear somewhat frothy. For the S&P 500, our 12-month target is now 7,800, which assumes 17% earnings growth next year and a very modest contraction in valuation from today’s levels.”
As for the bank’s stock picks heading into next year, Wilson names three sectors, while noting that he prefers one segment over semiconductors.
“Our favorite sectors include financials, industrials and healthcare… 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 of 2021, as the early cycle broadening and earnings combined with a more accommodative Fed provide the backdrop we have been patiently waiting for.”
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