Morgan Stanley turns bullish on U.S. stocks. Here's why it says the market lows have already been made.

Morgan Stanley has shifted to an overweight rating on U.S. stocks and bonds, anticipating a more synchronous earnings per share recovery aided by potential Fed rate cuts in 2026, dollar weakness, and AI-driven efficiency gains. Strategists, including Mike Wilson, project the S&P 500 could reach 6,500 by the second quarter of 2026, with a bull case target of 7,200 by June 2026, citing that the market has already experienced rolling earnings recessions. The bank believes the risk of recession has been significantly cut due to the recent U.S.-China tariff pause, forecasting seven rate cuts in 2026 and recommending higher-quality cyclical stocks, industrials, and utilities.

Analysis

Morgan Stanley has strategically shifted to an overweight position on U.S. stocks and bonds, driven by the assessment that the market has already navigated 'rolling earnings recessions' over the past three years, setting the stage for a more synchronous earnings per share (EPS) recovery. The bank projects the S&P 500, from a May 19 level of 5,964, could reach a base case of 6,500 by the second quarter of 2026, supported by an expected 21.5 price-to-earnings multiple on 12-month forward EPS of $302, with a bull case scenario targeting 7,200 by June 2026. This optimism is predicated on catalysts including seven forecasted Fed rate cuts in 2026, a projected 9% weakening of the ICE Dollar Index over the next twelve months, and broader realization of AI-driven efficiency gains. Morgan Stanley also notes that the recent U.S.-China tariff pause and the 'capitulatory price action' following 'Liberation Day' tariff announcements have 'significantly' reduced recession risk and potentially established market lows, assuming no deep recession. For the near term, elevated 10-year Treasury yields, currently at 4.53%, are expected to constrain equity multiples, keeping the S&P 500 within a 5,500-6,100 range in the first half of 2025, before yields are anticipated to fall to 3.45% by the second quarter of 2025. In terms of sector allocation, Morgan Stanley has upgraded Industrials (citing domestic infrastructure focus) and Utilities to overweight, favoring large-cap U.S. equities and higher-quality cyclical stocks with less leverage and cheaper valuations. However, Deutsche Bank's research presents a cautious counterpoint, highlighting rising U.S. fiscal risks indicated by a widening gap between U.S. Treasury yields and the U.S. dollar versus the Japanese yen, suggesting potentially declining foreign demand for U.S. debt.

Key Decisions for Investors

• Investors may consider re-evaluating U.S. equity allocations in line with Morgan Stanley's overweight stance, particularly towards high-quality cyclicals, industrials, and utilities, while preparing for potential near-term market consolidation influenced by bond yields.
• Closely monitor movements in the 10-year Treasury yield, as its trajectory towards Morgan Stanley's projected 3.45% by Q2 2025 is a key assumption for their bullish equity outlook, and deviations could signal revised market expectations.
• Assess currency exposure strategies in light of Morgan Stanley's forecast for significant U.S. dollar weakness, which could impact unhedged international asset returns and U.S. multinational earnings.
• Incorporate the U.S. fiscal risk perspective offered by Deutsche Bank, particularly regarding foreign investor appetite for U.S. Treasuries, as a potential moderating factor to the otherwise optimistic domestic growth and policy outlook.