Thoughts on the Market: Special Encore – Investors’ Top Questions for 2026

Podcast: Thoughts on the Market (Morgan Stanley)
Episode Date: December 30, 2025
Host: Michael Zesas (B), Global Head of Fixed Income Research and Public Policy Strategy
Guest: Serena Tang (C), Chief Global Cross Asset Strategist

Episode Overview

This episode revisits the most pressing debates and investor questions about the 2026 financial outlook, as answered by Morgan Stanley experts. The central focus is on the disconnect between economic performance and market resilience, particularly in light of persistent inflation, the AI-driven investment boom, and the anticipated trajectory for global growth, equity valuations, debt issuance, and currency trends in the coming year.

Key Discussion Points & Insights

1. Reflecting on 2025 and Setting the Stage for 2026

• Market Surprise in 2025: Despite higher-than-expected unemployment and slower growth, equity markets were buoyed by significant capital spending, especially in AI.

  • Quote: "The real surprise was the disconnect between the economy and financial markets." – [A, 00:00]

• 2026 Outlook: Optimism for modest global growth acceleration, inflation easing in the second half, and improving real incomes, particularly in the United States.

2. Top Investor Questions for 2026

A. Are Equity Valuations Stretched by the AI Boom?

• Client Concerns: Widespread worry about overvaluation, especially in AI-related stocks, reminiscent of the 1990s tech bubble.
• Tang’s Perspective:
  • Current companies are of higher quality, with efficient operations and strong cash flows.
  • Technology forms a larger share of indices, driving net margins up to 14% (vs. 8% in the 1990s).
  • Premium valuations are justified by higher margins and improved index composition.
  • A uniquely favorable policy environment (rate cuts, possible corporate tax cuts, ongoing deregulation) further supports valuations.
  • Quote: "Multiples in the US right now look more reasonable after adjusting for profit margins and changes in index composition." – [C, 03:24]
  • Quote: "We recommend an overweight position in US equities, even if absolute and relative valuation look elevated." – [C, 04:27]

B. Will Stock Market Gains Broaden Beyond AI Leaders?

• Observation: Recent growth heavily concentrated in a few AI leaders; healthier markets would see gains among more companies, especially mid and small caps.
• Tang’s Response:
  • Earnings growth in US equities expected to broaden, with small caps now preferred over large caps.
  • Early-cycle earnings recovery, supportive macro setup, and AI-driven efficiency support this trend.
  • Forecast: Above consensus US earnings growth at 17% for 2026, with Japan being the only other major region matching this view.
  • Underweight stance for Europe and Emerging Markets.
  • Quote: "We are expecting US Stock earnings to broaden out here... US equity strategy team has upgraded small caps and now prefer it over large caps." – [C, 05:34]
  • Quote: "Fed rate cuts, growth positive tax and regulatory Policies... act as a tailwind to earnings." – [C, 05:58]

C. Should Credit Investors Worry About AI-Driven Debt Issuance?

• Backdrop: AI CapEx forecasts predict $3 trillion in spending by 2028, half to be debt-financed.
• Concerns: Volume of new debt (~$1.5 trillion) could pressure credit markets.
• Tang’s Analysis:
  • Financing will include private credit, asset-backed securities, and especially US investment grade bonds (forecasted net issuance up 60% to $1 trillion).
  • Fundamentals remain sound, but the sheer supply leads to a "double downgrade" to underweight for investment grade corporate credit.
  • High yield bonds less exposed to this technical headwind and are favored, especially with falling default rates forecasted.
  • Quote: "We forecast around 1 trillion in net investment grade bond issuance, up 60% from this year." – [C, 07:58]
  • Quote: "We have double downgraded US investment grade corporate credit to underweight within our cross asset allocation." – [C, 08:19]
  • Quote: “High yield doesn’t really see the same headwind from the technical side of things.” – [C, 08:44]

D. What’s Next for the US Dollar?

• Review: The dollar weakened through 2025 as forecast by Morgan Stanley, linked to slowing growth and changing perceptions of the US on the world stage.
• Outlook for 2026:
  • Downward pressure to persist in the first half as US labor market concerns and FOMC uncertainty linger.
  • US-rate differentials compress, making FX hedging cheaper and encouraging further dollar selling.
  • Forecasts: Euro-dollar at 1.23, dollar-yen at 140 by mid-year.
  • Quote: "I think in the first half of next year that downward pressure on the dollar should still persist." – [C, 09:39]
  • Quote: “We see downward pressure on the dollar persisting in the first half—eurodollar at 1.23 and dollar JPY at 140 by the end of first half 2026.” – [C, 10:25]

Notable Quotes & Memorable Moments

• “When margins are higher, I think like paying premium for stocks is more justified.” – Serena Tang, [03:09]
• “This combination—monetary easing, fiscal stimulus, deregulation—rarely occurs outside of a recession... creates an environment that supports valuation.” – Serena Tang, [04:06]
• “Earnings growth in US equities is expected to broaden out here... that’s why we have upgraded small caps.” – Serena Tang, [05:34]
• “We forecast around 1 trillion in net investment grade bond issuance, up 60% from this year.” – Serena Tang, [07:58]
• “We have double downgraded US investment grade corporate credit to underweight within our cross asset allocation.” – Serena Tang, [08:19]
• “High yield doesn’t really see the same headwind from the technical side of things.” – Serena Tang, [08:44]
• “We see downward pressure on the dollar persisting in the first half.” – Serena Tang, [10:25]

Timestamps for Key Segments

• Episode framing & reflection on 2025: [00:00–01:03]
• Introduction to investor debates for 2026: [01:09–02:09]
• AI impact on equity valuations & bubble comparisons: [02:09–04:33]
• Market breadth & small cap outlook: [04:58–06:46]
• AI-driven corporate debt & implications for credit markets: [06:46–09:00]
• US dollar outlook for 2026: [09:00–10:41]

Conclusion

Morgan Stanley’s strategists address key investor debates heading into 2026, countering bubble narratives around AI, predicting broader earnings growth, advising caution on investment-grade credit, and expecting the dollar to soften further. Favorable US policy, strong corporate fundamentals, and a maturing AI investment cycle shape an outlook that champions US equities—especially small caps—and high yield credit over other regions and asset classes.