Investors have been pivoting toward high-quality megacap stocks as more companies adopt artificial-intelligence tools
High-quality megacap stocks now represent around 42% of the S&P 500.
The S&P 500 has recently resembled the way it looked five years ago, when investors started to play it safer, according to Morgan Stanley.
"The current setup resembles early-to-mid 2021, when leadership shifted toward quality after an early-cycle rebound post-covid," strategists at the investment bank led by Michael Wilson wrote in a note published Monday.
Higher profit margins are now likely to depend on the adoption of artificial-intelligence tools, with Morgan Stanley pointing out that forecast upgrades are most prominent among companies that have neutral to strong pricing power and where AI is core to the business.
High-quality megacap stocks, for which earnings growth is based on strong fundamentals and projected future profitability, make up about 42% of the S&P 500 SPX. Low-quality stocks, which may rely more heavily on debt and generate more volatile earnings, represent just under one-third of the index, according the New York-headquartered bank. It listed Apple $(AAPL)$, Micron Technology $(MU)$ and Coca Cola $(KO)$ as high-quality stocks that outperform most other companies in their respective sectors.
While a decline toward the 7,000 mark is possible for the S&P 500 if the war in Iran escalates or the Federal Reserve decides to raise interest rates at its meeting Tuesday and Wednesday, the "quality rotation" should support the strength of the index and even help to broaden participation, the strategists wrote.
"Weak balance sheets, high-beta growth, and low quality earnings factors started to underperform even as the S&P 500 advanced and growth strengthened," they said. "Today looks similar: our factor work favors high free-cash-flow yield, low [earnings-per-share] variability, strong balance sheets and high margins."
Headline inflation is also once again on the rise - and almost exactly in line with where it was in 2021, the strategists said, adding that back then, the shock was put down to being transitional, and today it could also be seen as temporary because of rising energy prices.
-Nora Redmond
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(END) Dow Jones Newswires
July 27, 2026 09:51 ET (13:51 GMT)
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