Podcast Summary: "A Bullish Case for Large Cap U.S. Equities"

Podcast Information:

• Title: Thoughts on the Market
• Host/Author: Morgan Stanley
• Episode: A Bullish Case for Large Cap U.S. Equities
• Release Date: June 16, 2025

Introduction

In the June 16, 2025 episode of "Thoughts on the Market," hosted by Morgan Stanley CIO and Chief U.S. Equity Strategist Mike Wilson, the discussion centers on why Morgan Stanley maintains a more optimistic outlook on large-cap U.S. equities compared to the broader market consensus. Wilson delves into various factors underpinning this bullish stance, highlighting stronger-than-expected earnings projections, sector-specific growth drivers, and favorable macroeconomic conditions.

Earnings Outlook

Wilson begins by underscoring the robust earnings backdrop that differentiates Morgan Stanley's view from the consensus. He states, “We remain more constructive on US equities in the consensus mainly because key gauges we follow are pointing to a stronger earnings backdrop than others expect the next 12 months” (00:30).

Key points include:

• Earnings Growth Projections: Morgan Stanley’s primary earnings model forecasts high single-digit earnings per share (EPS) growth over the coming year. Additionally, a secondary model, which accounts for cost efficiencies, projects mid-teens EPS growth by mid-2026, driven by operational streamlining through artificial intelligence (AI) adoption.

• Earnings Revisions: There has been a significant improvement in earnings revision breadth, shifting from -25% in mid-April to -9% as of the podcast date (01:10). This positive trend indicates increasing confidence in future earnings performance.

• Currency Impact: A notable tailwind for S&P 500 earnings is the weakening U.S. dollar, which has depreciated by 11% from January highs. Morgan Stanley's currency strategists anticipate a further 7% decline over the next year, enhancing earnings, particularly for large-cap companies with substantial international exposure (02:00).

Sector Highlights

Wilson identifies specific sectors poised to benefit from the current economic landscape:

1. Capital Goods:

   • Infrastructure Spending: There is a renewed focus on global infrastructure, driving demand for capital-intensive products. Wilson notes, “The combination of structural tech diffusion and a global infrastructure focus in many countries is leading to a more capital intensive backdrop” (02:30).

   • Capacity Utilization and Loans: Capacity utilization rates have turned positive for the first time in two and a half years, and commercial and industrial loans are climbing, reaching their highest levels since 2020.

   • Incentives for Investment: Bonus depreciation in the U.S. incentivizes equipment investment, directly benefiting capital goods companies.

2. Software:

   • AI-Driven Efficiency: Software companies are well-positioned to enhance free cash flow through generative AI (GenAI) solutions, which offer both revenue growth and cost reductions. Wilson emphasizes, “Software is in a strong position to drive free cash flow via Genai Solutions from both a revenue and cost standpoint” (03:15).

3. Financials:

   • Potential Deregulation: Large-cap financial firms could experience significant benefits from deregulation in the latter half of the year, potentially boosting profitability and growth within the sector.

Risks and Concerns

While the outlook remains positive, Wilson discusses several risks that could impact the bullish case:

1. Long-Term Interest Rates:

   • Interest Rate Sensitivity: A primary risk is the trajectory of long-term interest rates. Despite a favorable consumer price report that helped contain yields, geopolitical tensions have prevented rates from declining further. Wilson remarks, “The 10-year yield remains in close distance of our key 4.5% level above which rate sensitivity should increase for stocks” (04:00).

   • Volatility Trends: On a positive note, interest rate volatility has decreased from its April peaks, now approaching multi-year lows, which could stabilize the investment environment.

2. Underweighted Sectors:

   • Consumer Discretionary Goods: Morgan Stanley maintains an underweight position in consumer discretionary goods due to tariff-related challenges, weaker pricing power, and a late-cycle market backdrop, which historically leads to sector underperformance. Wilson notes, “Our long-standing consumer discretionary goods underweight is based on tariff related headwinds, weaker pricing power and a late cycle backdrop which typically means underperformance of this sector” (04:30).

   • Small Caps: The firm also continues to underweight small-cap stocks, which are adversely affected by higher oil prices, persistent interest rates, and the limited benefits from currency translation due to their predominantly domestic operations.

Valuations

A common client concern is the high valuation levels of large-cap U.S. equities. Wilson addresses this by emphasizing the importance of the rate of change in valuations over their absolute levels. He explains, “Our more sanguine view here is based on the fact that the rate of change on valuation is more important than the level in our mid-year outlook” (04:45).

Key insights include:

• Historical Trends: When EPS growth exceeds the historical median of 7% and the Federal Funds Rate decreases year-over-year, the S&P 500’s market multiple has risen 90% of the time, regardless of starting points.
• Forward PE Ratio: Under current conditions, with a forecasted market multiple near 21.5 times, Morgan Stanley views this as conservative. Should valuations increase by 10%, the bullish case for the S&P 500 over the next year becomes highly achievable.

Conclusion

Mike Wilson concludes the episode by reiterating the strong fundamentals supporting large-cap U.S. equities. The combination of favorable earnings growth, sector-specific tailwinds, and manageable risks positions these equities for potential gains. He encourages listeners to consider the structured optimism presented and to engage further by leaving reviews or sharing the podcast with others.

Notable Quotes:

• “We remain more constructive on US equities in the consensus mainly because key gauges we follow are pointing to a stronger earnings backdrop than others expect the next 12 months.” (00:30)
• “Software is in a strong position to drive free cash flow via Genai Solutions from both a revenue and cost standpoint.” (03:15)
• “Our long-standing consumer discretionary goods underweight is based on tariff related headwinds, weaker pricing power and a late cycle backdrop which typically means underperformance of this sector.” (04:30)
• “Our more sanguine view here is based on the fact that the rate of change on valuation is more important than the level in our mid-year outlook.” (04:45)

This comprehensive summary captures the essence of Morgan Stanley’s bullish outlook on large-cap U.S. equities, providing insights into earnings projections, sector performance, risk factors, and valuation considerations. It serves as a valuable overview for those who have not listened to the original podcast episode.