Street Calls of the Week
Investing.com -- Morgan Stanley strategists expect U.S. equities to extend gains as the Federal Reserve embarks on a rate-cutting cycle, arguing that the market is entering an early-cycle backdrop where nominal growth runs hotter.
At Jackson Hole, Fed Chair Jerome Powell signaled that cuts could begin in September, aligning with bond market expectations.
While equities initially rallied, the strategists point out that stocks have since consolidated.
“Our work shows that equities typically deliver strong performance during Fed cutting environments,” particularly when earnings growth runs above the long-term median, strategists led by Michael Wilson said.
The team believes this policy setting resembles a reflation playbook.
“The equity market is focused on the administration’s apparent desire to let nominal growth run hotter as the Fed cuts rates at the same time,” they wrote, likening the moment to early cycle phases such as those seen during Donald Trump’s first term.
The bank sees breadth in earnings revisions as evidence of a rolling recovery from a recessionary stretch that began in 2022.
Housing, consumer goods, manufacturing and parts of commodities have shown signs of turnaround, while sectors such as healthcare equipment, retailing and biotech led August’s improvements in analyst estimates.
Small-caps have begun to outperform in absolute terms, though relative strength remains limited. Strategists expect them to benefit more durably as cuts progress but stopped short of an overweight, citing a need for stronger earnings revisions.
“For now, we move to neutral on the small versus large cap relative trade,” they said.
Risks remain, particularly as the market heads into a weaker seasonal stretch. Hotter inflation could temper the scale of Fed easing, while sharply negative payrolls or a rise in unemployment could stoke volatility.
Still, Morgan Stanley argues that such weakness would ultimately bolster the case for deeper cuts, accelerating the early-cycle transition.
Beyond policy, the strategists pointed to AI adoption and corporate tax incentives as underappreciated supports for margins and free cash flow.
They estimate that automation and productivity gains could add as much as 50 basis points to S&P 500 net margins by 2027, leaning their forecasts toward the bull-case trajectory.
“While these risks are worth acknowledging and potentially trading, we remain buyers of dips and think any tactical consolidation would set up a strong finish to the year,” the team concluded.