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- [00:01]
A
Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley CIO and chief U.S. equity strategist.
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And I'm Dan Skelly, Senior Investment Strategist for Morgan Stanley Wealth Management.
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Today we're going to have a conversation about our views on the US stock market in 2026 and what matters most to retail investors in particular. It's Monday, December 8th at 9:00am in New York, so let's get after it.
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Dan, it's great to see you. You know we always talk about the markets together. I think this is a great opportunity for us to share those thoughts with listener Our view coming into this year, still pretty bullish for 2026. We've been bullish on 25 as you have, probably for similar, maybe some slightly different reasons. I think one of our differentiating views is that we do think inflation is still a major risk for individual investors and institutional investors, quite frankly, which is why stocks have done so much better. A concept I think you're well aware of. And I think the risk for retail is that it's going to be volatile. So point to point, we're still bullish as you are. How are you thinking about managing that point to point path? And how are you structuring your portfolio as we go into 2026 with a bullish outlook but understanding that it's not always going to be smooth.
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B
So like you said, we've also shared this view that next year is going to be positive, albeit there's going to be more volatility. And when I think about the two main risks that retail investors are facing today, we're one of them is definitely inflation. We're seeing that in services, we're seeing that in housing. You know, we've had the labor market shrink over the recent couple of quarters, so who knows if wage inflation pops up again. But there are ways to definitely hedge against that in an equity portfolio. We think, for instance, owning parts of the AI infrastructure cohort is one of the ways of hedging, whether that be in utilities, pipelines, energy infrastructure in general. These are areas that we think are a necessary hedge against inflation risk. And number two, are a positive diversifier. And second key point, Mike, just thinking about that diversification comment, look, we all know that in many ways the Mag 7 and the technology strength that we've seen this past year has driven a fairly concentrated market. I think what people, particularly on the individual side are recognizing less is just how much AI cuts across many other sectors in parts of the market. And again, we think that risk of over concentration is still out there. And we like the idea of thinking of embedding natural diversification into the equity portfolio.
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I mean, it's interesting inflation is part of that story too, because AI is somewhat disinflationary or deflationary. I think investing in things that can drive higher productivity even away from AI can mitigate some of that risk in the economic outlook. But if I think about the MAG7 dominance and just this concentrated market which you spoke about, if inflation re accelerates next year, which is one of our core views, as the economy improves, doesn't that broaden out kind of the opportunity set? And there's been this idea that, oh, you have to own these seven stocks and nothing else. I mean, part of our view for next year is that we think the market's going to broaden out. How are you set up for that broadening out? And how are you thinking about picking stocks and new themes that can work that maybe people aren't paying attention to right now?
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Yeah, it's a great point, Mike. And so on the first topic, we do think there's broadening and that's a combination of factors. Number one is just the market becoming more convicted about the Fed cutting path, which we've talked about and the firm's view reaffirms for next year. Number two is starting to see some of the benefits of deregulation which should impact maybe some of the more cyclical sectors out there, financials, energy being two of them. Maybe seeing more M and A activity too as a byproduct of deregulation. And that should bode better for mid and maybe small caps as well as they receive a M and a premia in the valuations. And I know you've talked about small caps recently in your commentary, but last point I'll make, Mike, and it comes back to AI. It almost feels like AI is this huge inflationary ramp at first to get to that deflationary nirvana down the road with productivity. I think one of the key factors we think about in terms of a bottom up perspective, which is what we focus on across the portfolio, is definitely pricing power. Who owns the pricing power and the key data and the key AI adoption outlook in order to absorb all the different tools and technology diffusion we've seen in the last three years. And that's going to play out, Mike, as you well know, across a variety of sectors and themes. So agreed, we should see broadening for all those varying reasons.
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So I mean, there are a couple areas I think, where we overlap. Financials, industrials, healthcare, some of the themes that I think we share bullish views on, what do you think those areas are within those sectors? You think that you have a differentiated view maybe than the consensus being financials, industrials, healthcare, that the market may be missing, which offers more upside?
- [04:57]
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Sure. I'll start with financials, which has been an overweight call for us for some time, as I know it has for you as well. I think that cyclical reacceleration in the economy is one part. I think the Fed cutting is another part of. I think deregulation is clearly another driver. Fourth, capital markets recovery, which we have seen. Now we had a little bit of a technical lull with the government shutdown in terms of filings and issuance, but we see all of the pipeline indicators indicating green lights for next year in terms of recovery. I think the one thing I would argue that I've observed in looking at all of our vast data sets is that despite all these different bullish factors, the this still maybe has been a theme or a sector that investors have traded in and out of. I don't think I've even seen a real strong consistent overweight. So I think number one, that's an opportunity. And last point is, listen, there's different subsector bifurcation going on as you know, within the industry, whereas money centers and large banks are performing really well. The same is not the case of regionals and alts managers and there are varying reasons for that. But we would even argue, Mike, there could be catch up trades within the sector next year.
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Yeah, I would agree on that. I mean the regional over money centers and actually regionals over alt managers because I mean, I think the Treasury Secretary's talked about this, you know, trying to get the regulated banking system kind of back in the game may actually be an opportunity to take share back from some of those alt managers which have actually done quite well. What about on health care? We upgraded that back in the summer. I think you've been constructive on parts of health care. Like what do you think people are missing there? Why, why could that be a good sector for next year?
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Yeah, we were definitely, I'll say earlier than you and Rong, you had really good timing in terms of your healthcare upgrade last summer. And look, the sector was out of favor for two years. What we think we observed in the kind of July, August period is first and foremost, I think we got past the point of maximum policy concern and risk. And ironically we saw some kind of nominal or surface level deal signed with the government around most favored nation pricing. And it was really not a lot to write home about. It wasn't as egregious as a policy inflection as some had feared. So I think that was the first key catalyst. Second, we just saw really good revisions. Breath and I know this is a comment you make a lot in your work, but we saw across big pharma tools and life science, medical technology and devices, we saw really good positive earnings revisions coming out of the third quarter and even starting the second quarter. Thirdly, I think if you're talking about an M and A and capital markets recovery, you can't not talk about health care. I think that's a space that'll be ripe for dealmaking. And then just fourth. Right. Look, as the market broadens out and as people are stopping or maybe slowing the crowding and the key leadership, they're going to go again from AI enablers to AI adopters. And we think AI is going to be a vector that cuts across the healthcare industry in a really positive way.
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Yeah, and I mean the efficiencies that are possible in the healthcare sector seem immense. It appears to me that that's going to be an area where there's probably some new solutions, some new companies we don't even know about yet. So to me that's a very exciting area that's been dormant for quite a while. What about consumer Dan, it's been this K economy. It's been a very bifurcated high end versus middle income, lower income. What are the themes within consumer that you're finding and putting the work in your portfolio?
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Yeah, we've talked a lot Mike, in the last year or so about playing consumer platforms, particularly domestically oriented versus global consumer brands. There's a couple of key drivers behind that. But first, when you look at what's going on in consumer land, and Simeon Goodman's been a really good analyst looking at this theme over time. In many ways it's starting to resemble the Mag 7 in terms of winner take all phenomenon. If you look at some of the major consumer big box platforms, they're taking 50, 60% of share of total retail sales. Just a couple of companies. Number one, we're really focused on platforms where market share gains, free cash flow and revenue, recurring revenue in particular, are leading to even stronger competitive moats, particularly in a capital intensive industry. What we've observed about retail is that as those leaders in big box areas take more share, they can reinvest that winning capital in their advertising growth in their online channel and widen their moats even more. Secondly though, in order to have a positive theme. I've always said you got to fund it from somewhere. And so what we've observed again over the last year or so is when I think about some of the even highest quality global brands, they've suffered seeing less traction in China and that's amid less of a willingness from Chinese consumers to own American and European brands. There's a lot to that. But I think culturally obviously the trade war, the AI war for prominence is leading to maybe some of that lack of cultural traction. Secondly, we've also I think started to see the growth of AI tools start to weigh on established brands. I think what makes a brand cool and the barriers to entry in terms of creating brands is going to go down in the future because of AI influencing and advertising tools. And so simply put, we continue to like the big box consumer platforms across clothing and food, housing across E commerce. That continues to be one of our higher conviction themes.
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All right, Dan, I want to come back to kind of AI infrastructure. AI spending has been the big big theme but there's other types infrastructure spend and capex that's been dormant quite frankly. And with the big beautiful bill perhaps incentivizing some of that, how does that play into your thought process around other industrial stocks that could benefit?
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B
Absolutely. Mike, you cited the AI infrastructure spending we think continues kind of unimpeded going into next year. Number two, we think the Fed cutting just creating better financing conditions in terms of bigger projects. You mentioned as well the fiscal incentives. And look I think Chris Snyder has been spot on the last year or so talking about reshoring production winds coming back to the US I don't think this is certainly as cognizant or on the minds of individual investors, maybe not even institutional investors. But the US is winning manufacturing production share and has been for some time and we've seen that no doubt ramp up post the announcement of the big beautiful bill. No doubt. But we think that has implications Mike for stocks and stock picking within what we would call shorter cycle themes. I think whether that be in logistics and transports or H Vac or some of the non resi non data center related verticals. There are a whole bunch of stocks that have been dormant for two to three years as we've been in this ism recession that we think could certainly wake up next year as things broaden out.
- [11:37]
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Yeah, we would agree with that I guess. Lastly there's always this Johnny come lately fear factor of well stocks are up a ton, my neighbors bragging about how much money they're making. So I Must have missed it all. And I think embedded within that is this fear of valuation. The valuations are now very rich. What's your response to individual clients about? It's not too late, they haven't missed it. It's still a bull market. In fact, we would argue a new bull market began in April with a new economic cycle. Like what is your response to those folks who have that angst?
- [12:10]
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Two things. One is the market today looks totally different than it did in the past and AI is no doubt one big part of that. The composition of the market in many ways is higher quality, less debt, more recurring revenue, big call option on productivity coming from AI, earnings power, et cetera. So we think the market should trade at richer levels than it did in the past. Point number one. Point number two, we would say whereas most people say time is your friend for individual investors, they would also say valuation is no short term or short run indicator, but it's the best long run indicator. And looking at today's again extended levels of valuation relative to history, they would say that's not going to play out well over the long run. I would actually take the other side of that. I think that the earnings and the economic potential unleash not just from AI, but some of these fiscal and monetary policies could create tremendous margin and earnings potential over the long run. And so I think today we're looking at a level of multiples that appears artificially high and based on what could be a big earnings inflection point in that multi year timeframe, could frankly just be superficially high.
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Well Dan, it's always great to get your perspective. I always enjoy chatting with you. Thanks for coming on the show and sharing it with our listeners. Great to see you.
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Thanks Mike.
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And thanks to our listeners. Thanks for tuning in and let us know what you think by leaving us a review. And if you find thoughts on the market worthwhile, tell a friend or colleague to try it out.
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