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Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley CIO and chief U.S. equity strategist. Today on the podcast I'll be discussing the changing equity market leadership. It's Tuesday, June 30th at 11:30am in New York, so let's get after it. Something is happening in plain sight, but still isn't fully appreciated by investors. The market's leadership is changing and as usual, by the time everyone agrees that it's happening, the easier money will probably have already been made. Coming into this year, the primary differentiation to our view was that the economic and earnings outlook were much stronger than the consensus believed. That view was built around a few simple but powerful ideas easy comparisons after a three year rolling recession. Lean cost structures, pent up demand, fiscal support from capex incentives and tax cuts, deregulation for the banks, and a monetary backdrop that was increasingly supportive to the liquidity channel. Putting those together, the setup looked like a classic early cycle Revenue growth returning on top of lean cost structures leads to strong operating leverage and well above trend earnings growth. Fast forward to today and that's exactly what's happened. The median stock in The S&P 1500 is now growing earnings at a double digit pace, the fastest since the post Covid boom. Revenue growth has returned with the median stock growing its top line by 7%. That's a rolling recovery showing up where many investors still aren't looking. For much of this year, and particularly the past few months, most investors didn't want to hear that story. The Iran conflict pushed oil sharply higher. Rate cut expectations turned into hike expectations. Faced with these headwinds, investors crowded back into the AI trade, especially semiconductors and memory in particular. To be clear, earnings revisions in semiconductors have been spectacular. The move wasn't irrational, but when something becomes the most owned, most loved and most obvious area of the market, it becomes harder to surprise on the upside. That's where I think we are now. The hyperscalers have started to underperform and that may be an early warning sign for semis, which are the key beneficiaries of the AI spending boom. Earnings revision breadth for semis is pressing against historical extremes. Again, this does not mean the AI cycle is over, but it does mean that the rate of change may be peaking. And when price momentum starts to fade in a crowded trade, it can lead to significant setbacks. It can also give other parts of the market room to breathe. In short, the broadening trade is back. The equal weighted index and small caps are outperforming again. More importantly, the groups we have been recommending consumer discretionary goods. Transports and regional banks have already started to show relative strength over the past six weeks, even though positioning and sentiment remains neutral to negative. That's the kind of combination I like Better price action, improving earnings and Investors still skeptical One reason I've been more constructive on the consumer than others is that I've also been more bearish on oil. That view is not dependent on a grand deal between the US and Iran, although that obviously helps. The signals were already there. The Brenta WTI spread narrowed and energy stocks began underperforming from the day the conflict started. The market was telling us something before the headlines confirmed it. And longer term, I think the conflict has put the world on notice. This choke point around the Strait of Hormuz must be solved. It's no longer a risk that the world is willing to tolerate. New routes, new supply and new energy strategies are likely coming. Necessity is the mother of invention and I would not underestimate the world's ability to adapt. A less problematic oil backdrop helps the broadening trade too. So does the Fed, at least on rates. The June FOMC meeting told us two things Forward guidance is going to be diminished and the reaction function is now focused more squarely on inflation. My view is that falling energy prices, peaking tariff related inflation and contained services and housing inflation keep the Fed on hold where rather than hiking this year. If that's right, lower than expected real rates could be a positive surprise for equities and another tailwind for the broadening of performance. The key variable to watch at this point is liquidity. This Fed is unlikely to be as proactive with balance sheet support, just as the real economy needs More Capital for CapEx and the markets are dealing with more equity in credit supply. That's the near term real risk, especially for popular momentum trades. Bottom line, the market may look choppy and even weak at the index level over the next month, but the message underneath is improving. Earnings are broadening, oil is falling. The shift is already underway. With crowded momentum trades wobbling and the under owned areas of the market starting to lead, investors can either wait for it to become more certain or position before it becomes obvious and fully priced. Thanks for tuning in. I hope you found it informative and useful. 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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