Morgan Stanley: The market undervalues the bull market in US stocks, and six catalysts will ignite risk appetite.

The latest research report released by Morgan Stanley stock strategist team led by Wall Street's top strategist Michael Wilson shows that the market consensus expectations are significantly underestimating the positive impact on risk appetite and valuation generated by a combination of multiple bullish catalysts as we enter 2026. Wilson and his team of Morgan Stanley strategists stated that the biggest surprise in 2026 may not be just a few high-weighted tech stocks continuing to lift the S&P 500 index, but rather the "median stock in the S&P 500 index" seeing an increase in both earnings growth and valuation multiples, leading to a broader market rally and "market diffusion". The "median stock" mentioned by Morgan Stanley in the research report refers to a statistical concept: in a sample of stocks (usually the S&P 500 components), after sorting the stocks from low to high based on a certain indicator (in this research report it is the expected P/E ratio), the "median stocks" are those that are at the 50th percentile and are considered as the most typical stocks. Morgan Stanley also mentioned the phenomenon of "about 3 P/E multiple discount for the S&P 500 index's median stock relative to market-cap weighted index", to elaborate further: apart from a few highly-weighted tech giants, a more widespread group of "ordinary S&P 500 index components" still have significant room for valuation repair/upward revision under multiple positive catalysts. Wilson set the year-end target for the S&P 500 index at 7800 points in 2026, and described the "multiple synergistic driving factors" as facilitating a rolling cyclical recovery for the U.S. stock market. Therefore, Morgan Stanley defines 2026 as a "broad-based stock market bull market under a rolling recovery", advocating a return of market risk appetite and multiple cyclical industry resonance, with cyclical stocks leading the second stage of the bull market. The Morgan Stanley strategists believe that the current stock market is at the beginning of a new earnings cycle and a structural bull market, with the core leadership of the U.S. stock market expected to shift from large-cap tech stocks benefiting from AI like NVIDIA, Google, and Microsoft to mid-cap and cyclically core industries. The Morgan Stanley strategists emphasize that under the investment theme of a "U.S. economic soft landing + rolling recovery" in 2026, cyclical stocks (especially strong cyclical industries, financials, and consumer discretionary) are expected to benefit comprehensively, with performance significantly outperforming the average benchmark performance of the past two to three years. "We believe that the market consensus is still underestimating a series of bullish catalysts - from deregulation factors to operating leverage and to loose monetary and stimulative fiscal policies - which collectively bring about positive impacts," wrote Wilson and the team of Morgan Stanley strategists. The team led by the strategist summarized a number of key tailwind factors that they believe are still not fully priced in the American stock market: Earnings growth trajectory: Morgan Stanley's calculation model points to a high earnings per share (EPS) growth rate of fifteen to twenty percentage points towards later 2026, driven by factors such as decreasing expense growth and positive operating leverage brought by pricing power; Morgan Stanley also expects significant acceleration in AI adoption scale this year, driving a 40 basis points expansion in net profit margin for the S&P 500 index overall. Deregulation: The neutral-weighted financial sector will be a key beneficiary, with the finalization of the eSLR rule and other changes expected to "ignite significant release of bank capital productivity". The Trump administration's relaxation of bank regulations, as well as lending guidance following deregulation, is expected to drive strong growth in commercial and industrial loans. Monetary policy: Morgan Stanley economists expect further interest rate cuts by the Federal Reserve in January and April 2026, with the Fed also purchasing $400 billion in short-term government bonds monthly to provide stronger liquidity supply to the market. Morgan Stanley predicts that as more incremental liquidity funds flow into long-term U.S. bonds, the 10-year Treasury yield, known as the "global asset pricing anchor," will reach 3.75% in the second quarter of 2026, which will greatly favor a significant increase in market risk appetite. ISM cycle turning point: The Trump administration is driving the reshoring of high-end manufacturing such as chips to the U.S., indicating that the 45-month ISM cycle volatility and the lagging effects of relatively low interest rates, as well as the rebound trend in breadth of profit upward revision, all point to an acceleration in U.S. manufacturing activity this year. Consumer tailwind: The shift of service to goods in the "wallet share" is underway, while stronger pricing power for goods. The OBBBA (i.e. the Trump administration's "big and beautiful" bill) is expected to increase U.S. personal comprehensive income by approximately $65 billion in 2026. Morgan Stanley indicates that in 2025, there was a year of tariff policy, tightening immigration, and the enactment and intensive execution of the Trump administration's "big and beautiful" bill, and from 2026 to 2027, various major policy frameworks stimulating economic growth will be settled down, shifting the focus of the U.S. economy from "policy disturbance" to how businesses and households adjust spending in the larger context of tax cuts from the "big and beautiful" bill and the revival of consumer confidence stimulated by the Trump administration. Weakening dollar and oil prices: A weakening dollar supports overall profit upward revision for the S&P 500 index in the background of approximately 30% of overseas sales exposure; while gasoline prices are at a five-year low, providing a positive buffer for consumers. "The 'Goldilocks' soft landing is getting closer! Morgan Stanley bets on the end of the 'AI investment theme solo dance era'" The OBBBA (i.e. the so-called "big and beautiful" bill passed by the Trump administration in 2025 will strongly drive economic growth starting in 2026, combined with the short-term inflation disturbance caused by the eventual price increase due to Trump's tariff policy being proven temporary, as well as the fervent progress of AI data center construction around tech giants like Google focusing on AI computational infrastructure, will collectively lead to a mild growth macro-environment in 2026 for the U.S. economy. The so-called "Goldilocks" style U.S. macroeconomic environment refers to an economy that is neither too hot nor too cold, but just right, maintaining moderate growth in GDP and consumer spending and a long-term stable trend of "moderate inflation" while the benchmark interest rate is on a downward trajectory. Overall, Morgan Stanley expects the U.S. economy to gradually move out of a highly uncertain state in 2026 and return to a positive track of "moderate growth". Morgan Stanley states that the U.S. stock market has exited a three-year period of "rolling recession" and officially entered the "rolling recovery" stage, with compressed cost structures, robust profit revisions, significant improvement in corporate operating leverage, and suppressed demand release, all contributing to a "typical early-cycle" environment; on a macro level, Morgan Stanley predicts that the Fed's interest rate cut trajectory will open a new capital expenditure cycle, real interest rates will return to normal, and corporate investment (especially in AI and manufacturing) will be a new growth engine. Therefore, Morgan Stanley defines the current situation as the "second stage bull market under a rolling recovery" - led by profit expansion and sector rotation of cyclical industries, with market risk appetite returning comprehensively, and the market having broader investment breadth and resilience. Morgan Stanley's strategy team advises investors to be "overweight" financials, industrials, healthcare, and consumer discretionary in 2026; "underweight" consumer staples and real estate; and "equal-weight" technology and energy sectors.