MW Pullbacks will be shallow as market risks diminish, says Morgan Stanley
By Jules Rimmer
It's the business cycle, not a policy agenda, that's driving the market higher
Morgan Stanley's Mike Wilson has been consistently bullish throughout the last year, predicating his enthusiasm for stocks primarily on strong earnings of U.S. companies
The U.S. stock market is being driven higher by a combination of factors that persuade Morgan Stanley's chief equity strategist pullbacks will be shallow and the market's trajectory remains higher.
The drivers identified by Mike Wilson in his weekly warm-up research note published Monday are the strong earnings growth the S&P 500 is exhibiting so far this reporting season, an expanding capex cycle, the ongoing adoption of AI and the fact that, having been buffeted by geopolitical headwinds, passive investors are essentially under-risked.
The rolling recovery in earnings has consistently been a pet theme of Wilson's for the past year. He notes that at this early stage in the reporting season, positive surprises for companies announcing results are running roughly double the long-term average. Moreover, earnings estimates for the second quarter and full year 2026 are continually being revised higher and have been raised by 2% and 3% respectively in April alone.
Forward earnings estimates are accelerating.
These earnings revisions are contributing to the capex cycle too. In conjunction with the tax incentives accruing from the One Big Beautiful Bill Act and structural support from the build-out of AI data centers, capex growth is running at 10%, and this is helping to keep top-line growth intact for the S&P 500 with sales surprises running around 2% so far this quarter.
AI adoption is another market vector building momentum. This is compressing cost structures, lowering wage costs and boosting earnings growth, especially among small caps, driving margin expansion. Morgan Stanley's economists tell Wilson output per employee is picking up, especially in industries with a high exposure to AI.
A year ago, 13% of S&P 500 index constituents noted benefits deriving from AI adoption. In the first quarter of 2026, that figure is 25%.
In industries with high AI exposure, output per employee rose faster and accelerated more than other industries.
WIlson and his team of Diane DIng, Michelle Weaver, Nicholas Lentini and Andrew Pauker, have been doing some research into the potential impact on equity markets of the mid-term elections in November. They consider the drivers for stocks to be foreign policy, tariffs and deregulation and note these all remain within the purview of President Donald Trump and levers he can pull.
From a historical perspective, earnings growth this year is running about ten percentage points higher than the average for the second-year period of presidential cycles. For Wilson, this reinforces his conviction that the business cycle is ultimately a more important arbiter of market direction than a policy agenda.
Given this multiplicity of supportive factors for the market, rWilson observes investors are looking at the current recovery and asking themselves if the market will give them another opportunity to add risk. Owing to the under-risked positioning of passive investors, Wilson believes the dips will be fleeting.
Concerns about the Fed's transition or rising inflation could provoke periodic "spikes in bond volatility and/or funding market stress" but from Wilson's perspective these will be manageable.
-Jules Rimmer
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(END) Dow Jones Newswires
April 27, 2026 07:15 ET (11:15 GMT)
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