Following a sustained recovery since March, the S&P 500 index has rebounded 17% from its lows. Morgan Stanley believes the market has largely digested major risks, leading to an upward revision of its year-end target price.
In his latest outlook report, Morgan Stanley's Chief U.S. Equity Strategist Mike Wilson raised the firm's year-end 2026 target for the S&P 500 from 7800 to 8000 points, setting a mid-2027 target of 8300 points. Wilson's team noted that the current market is not ignoring risks but has completed a substantive adjustment in terms of valuations and market breadth.
The report argues that with Waller at the helm of the Federal Reserve, the U.S. stock market rally does not depend on rate cuts. Historical backtesting shows that stock returns remain robust in an environment where the Fed holds steady and earnings growth is strong, with a median gain of 14%. Meanwhile, the Trump administration's "rebalancing" policies are structurally supporting U.S. equities—by narrowing the trade deficit, expanding domestic investment, and increasing the real income of low-income groups, they alleviate economic structural vulnerabilities and reduce the systemic risk premium.
Internal market adjustments are complete, and risks are fully priced.
Currently, external interpretations of the S&P 500's sub-10% decline in March are biased, overlooking deeper internal market adjustments. Approximately half of the stocks in the Russell 3000 have corrected at least 20%, and the forward price-to-earnings ratio of the S&P 500 has compressed by 18% from its peak. This is not market complacency but rather the market's forward pricing of multiple risks over the past six months—including the Iran war and oil price shocks, AI technological disruption, and private credit risks.
With major risks already priced in, what drives further market upside? The report believes that after Waller assumes the Fed chairmanship, stock market gains will not rely on monetary easing. Historical data indicates that under a combination of a paused Fed and strong earnings growth, the median stock return is 14%, primarily driven by earnings growth.
Beyond earnings growth, the nature of inflation is also crucial. Income growth is positively correlated with goods inflation, and enhanced pricing power driven by strong demand provides positive support for stocks, provided this trend does not trigger a new Fed rate-hike cycle. As for the risks of recession or a growth slowdown that the market fears, the trigger conditions are stringent: oil prices would need to persistently exceed the $130-$150 per barrel range, and earnings trends would need to deteriorate significantly; both conditions occurring simultaneously would be required to induce a recession. This is also not the expected scenario.
From Rebalancing to U.S. Stock Divergence Faced with mounting debt pressures, the Trump administration is attempting a different solution—not through austerity, but through growth. Policy focus is advancing economic rebalancing across three dimensions: trade, investment, and income inequality. Currently, rebalancing is showing several positive signals: the trade deficit as a share of GDP is narrowing, fixed investment is increasing significantly, real wages for low-end service and manual labor positions are gradually stabilizing or improving, and private-sector job growth is occurring alongside a reduction in government employment.
Where will this policy path lead U.S. stocks? If the optimistic scenario materializes, the S&P 500 could rise to 9400 points, with earnings expansion exceeding expectations. Potential drivers include AI-led productivity gains or companies scaling back hiring ahead of full technology implementation.
In a pessimistic scenario, the index could fall to 5900 points, triggered by overheating inflation forcing the Fed to hike rates while Waller advances balance sheet reduction, leading to increased bond market volatility and funding market stress, thereby suppressing valuations and dragging on earnings growth. The probability of this scenario occurring before year-end is extremely low, but if the bullish scenario materializes first in the second half of the year, with inflationary pressures lagging behind a historic demand recovery, its probability would conversely increase.
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