M. Stanley lifts S&P 500 target, upgrades small-caps as rolling recovery begins

Investing.com -- Morgan Stanley raised its 12-month S&P 500 target to 7,800, saying stronger earnings growth and a broadening in leadership are set to drive the next phase of the equity rally.

April marked the end of a three-year rolling recession and the start of a new bull market, the bank said, supported by leaner cost structures, firmer pricing power and a historic rebound in earnings revisions breadth.

Third-quarter results offered early evidence, with the S&P 500 delivering a 2.2% revenue beat rate and the median Russell 3000 company posting 8% earnings per share (EPS) growth, its strongest pace in four years.

The new target is based on 22 times forward earnings of $356. Morgan Stanley expects S&P 500 EPS of $272 in 2025, $317 in 2026 and $356 in 2027, representing 12%, 17% and 12% growth.

Strategists led by Michael Wilson say key drivers include the return of positive operating leverage, greater pricing power, AI-driven efficiency gains, and accommodative tax and regulatory policies that support a transition from public to private-sector-led growth.

“We expect valuation to compress modestly versus current levels, but stay elevated relative to history at 22x,” Wilson and his team wrote. “Our work shows that it’s rare to see meaningful multiple compression in periods of above-median EPS growth (~7-8%) and accommodative monetary policy,” they added.

Morgan Stanley also expects leadership to widen as lagging areas of the market recover. It sees small caps outperforming large caps and cyclicals outperforming defensives, and upgrades small caps to Overweight relative to large caps.

Sector-wise, Financials and Industrials remain Overweight calls, while Consumer Discretionary Goods is upgraded to Overweight from Underweight. Healthcare is also raised to Overweight as the bank’s preferred exposure to quality growth.

The missing ingredient for the typical early-cycle broadening has been rate cuts, strategists said. Weaker labor data, along with the administration’s desire to “run it hot,” is expected to push the Federal Reserve toward a more accommodative stance over the next 6–12 months.

Delays in labor releases due to the government shutdown and tighter liquidity conditions pose near-term risks, and the team warns that tighter liquidity has already become a headwind for high-momentum areas. But they argue that moderating employment trends ultimately support the case for easier policy.

The forecast reflects the view that a rolling recovery is underway, with earnings set to strengthen across a wider group of companies as volumes, pricing and operating leverage improve.

“This narrative remains underappreciated, and we believe there is significant upside to earnings over the next year as the recovery broadens and operating leverage returns with better volumes and pricing in many parts of the market/economy,” the strategists wrote.