Morgan Stanley's Wilson: Weak employment data will force the Federal Reserve to turn to small-cap stocks and the consumer sector for recovery opportunities.

Despite the recent market downturn, especially impacting high momentum and high beta growth stocks, Morgan Stanley's Chief US Equity Strategist and Chief Investment Officer Michael Wilson believes that the current weakness may foreshadow a positive mid-term outlook. In a report, he stated, "We view the market's internal weakness as a signal that we are closer to the end of this correction rather than the beginning," and advised investors to see this reset as an opportunity to position for a potential recovery. The strategist also pointed out that as of October, alternative labor market data showed further signs of weakness, with indicators such as the ADP report, Challenger layoff data, and continued unemployment claims all pointing to a weakening job market. He added, "We believe the stock market discounted changes in labor data back in April," meaning that modestly weak official employment data could actually be favorable for the stock market as it may prompt the Fed to cut rates more aggressively. Wilson explained that the cancellation of the October jobs report and the delay in November data (to be released on December 16) have brought uncertainty to the Fed's decision at the December 10 meeting. He referred to this timing as "an unusually uncertain outlook for the Fed meeting," as investors weigh conflicting signals from the September data showing both stronger-than-expected nonfarm payrolls and rising unemployment rates, potentially leading to continued market volatility. Tightening liquidity conditions have become a headwind for the market, exacerbated by an increase in the Treasury General Account (TGA) during the government shutdown and restricted appropriations. However, Wilson noted signs of relief, stating that "colleagues forecast a significant decline in the TGA in the coming weeks" (followed by an increase by the end of the year), coupled with the Fed's end of quantitative tightening on December 1, which should improve liquidity conditions. Despite facing short-term challenges, the strategist remains "highly confident in the 12-month bullish outlook for the S&P 500 index," expecting a 17% earnings growth in 2026, compared to the market's general expectation of 14% or lower. He emphasized raising small-cap stocks and non-essential consumer sectors to overweight, pointing out encouraging signs that "even in the recent sell-off, earnings revisions breadth remains resilient," with small-cap stocks showing the "largest upside inflection in forward earnings expectations."