Thoughts on the Market
Episode: Why the ‘Rolling Recovery’ Has Already Begun
Date: September 22, 2025
Host: Mike Wilson (Morgan Stanley CIO and Chief U.S. Equity Strategist)
Guest: Andrew Pawker (U.S. Equity Strategy Team)
Overview
This episode dives into Morgan Stanley’s outlook on the U.S. equity market’s transition from a rolling recession to a rolling recovery, marking the beginning of a new bull market. Mike Wilson and Andrew Pawker address frequent client questions about where we are in the economic cycle, the Fed’s rate cut strategy, and why rising inflation may actually be positive for equities. The discussion also touches on market internals, earnings dynamics, yield curve behavior, and timing signals for small cap stocks.
Key Discussion Points & Insights
1. Rolling Recession to Rolling Recovery: Where Are We Now?
- Timeline and Sectors Affected
- The rolling recession began in 2022, sparked by the post-COVID demand pull-forward, first hitting sectors like technology and consumer goods.
- The recession then cycled through housing, manufacturing, commodities, and transportation, with only AI CapEx, consumer services, and government showing strength.
- Quote:
"It started with the technology sector and consumer goods... then we’ve had recessions in housing, manufacturing, and other areas in commodities, transportation." – Mike Wilson [01:04]
- Liberation Day: Key Turning Point
- Liberation Day, coinciding with a spike in job losses due to government actions (referenced as "Doge"), marked the culmination of the rolling recession.
- Quote:
"We feel like the rolling recession has rolled through effectively the entire economy. In addition to the labor data that now is confirming that we’ve had a pretty extreme reduction in jobs." – Mike Wilson [02:25]
- Early Cycle Backdrop Emerging
- Data such as median stock EPS growth turning positive (+6%), V-shaped earnings revision recovery, and market internals (like the cyclical/defensive ratio rebounding) all signal the start of an early cycle phase.
- Quote:
"Median stock EPS growth, which had been negative for a lot of the 2022–2024 period is now actually turning positive." – Andrew Pawker [03:40]
2. Interplay Between the Fed and the Equity Market
- Rate Cut Expectations vs. Market Needs
- The Fed’s recent 25 basis point cut was anticipated, but is considered modest compared to what the market (especially cyclicals) desires.
- The lag in labor market deterioration—due in part to slow reporting of layoffs—means the Fed may cut more aggressively soon, enabling further market rotation.
- Quote:
"That tension between the Fed’s delay to get ahead of the curve and the market’s need for speed... is where we think that we have to wait for that to occur to get the full rotation." – Mike Wilson [05:26]
3. Yield Curve Risks and Market Perceptions
- Back-End Yield Curve Dynamics
- Unlike past cycles, aggressive Fed cuts last fall led to back-end yield (10yr, 30yr) sell-offs, driven by fiscal imbalances.
- Current concerns are mitigated by improved fiscal clarity (thanks to passed legislation), and rates are comfortably below problem thresholds (4.5%).
- Quote:
"That’s the first time we’ve ever seen that in history where the Fed cuts that aggressively and the back end moves out. And this is a function of just all the fiscal imbalances and the debt issues that we face." – Mike Wilson [06:41]
- Quote:
"We have the one big beautiful bill signed into law. We know what the deficit impact is. So there is more clarity for the bond market on that front." – Andrew Pawker [07:54]
4. Why Accelerating Inflation May Help Equities
- Inflation’s Silver Lining for Earnings
- Accelerating inflation correlates with improved pricing power and profit margins, benefiting broader earnings—especially for small caps.
- Past periods of high inflation (e.g., 2021) were strong for earnings across the board.
- The Fed’s expected tolerance of higher inflation in 2026 should further support equities.
- Quote:
"That earnings will be better. Our call over the next 12 months is not about multiples or the Fed so much, but that we think earnings are going to end up being better than people expect because... now inflation is re-accelerating as demand comes back and that is actually going to fall to the bottom line." – Mike Wilson [09:10]
- Equity Risk Premium Can Stay Low
- Investors may accept a lower equity risk premium as equities act as a partial hedge against inflation, supporting higher valuations.
5. Market Rotation and Small Cap Timing
- Reading the Rotation Signs
- Large cap exposure has been reduced; attention is shifting to small caps, but timing remains key.
- The strategy waits for:
- Fed funds rate to equal/below 2-year Treasury yields (currently still above by 60–65 bps)
- Positive small-over-large relative earnings revisions (which have lagged for four years)
- Quote:
"The thing that we’ve been really patient about is just waiting for the Fed to lower rates to a level that’s more conducive for these businesses... At the end of the day, that should translate into better earnings revisions." – Mike Wilson [10:48]
- Small caps have outperformed in absolute terms since Liberation Day, but leadership versus large caps is still pending.
Notable Quotes & Memorable Moments
-
On the market’s transition:
"We’ve rarely seen this kind of a V shaped recovery coming out of Liberation Day, which of course was the final blow to the earnings revisions lower." – Mike Wilson [02:56]
-
On fiscal clarity and the rates market:
"Now that is a known, known... We know what the deficit impact is. So there is more clarity for the bond market on that front." – Andrew Pawker [07:54]
-
On inflation’s impact:
“When inflation is accelerating, that’s a sign that pricing power is pretty good. And we actually see broader earnings... that was just pure profit for a lot of these businesses.” – Mike Wilson [08:56]
-
On signs for a renewed small cap run:
"We’ve been underweight small caps for really four years and they’ve underperformed that entire time." – Mike Wilson [10:42]
Timestamps for Important Segments
- 00:49–02:25 – Discussion of ending the rolling recession and entering early cycle
- 03:29–04:49 – Signs of rolling recovery: earnings, inflation correlation, market internals
- 04:49–05:26 – Fed's rate cuts and market rotation needs
- 06:20–07:43 – Yield curve concerns and fiscal policy context
- 08:51–10:20 – Why inflation helps earnings and stocks
- 10:20–11:56 – Criteria for small cap outperformance and market rotation
Conclusion
Mike Wilson and Andrew Pawker articulate a cautiously optimistic case for the U.S. equity market, positing that the rolling recession has ended and recovery is underway. They emphasize the importance of monitoring Fed policy, yield curve dynamics, inflation’s impact on earnings, and internal market rotation signals—especially for timing a small cap resurgence. Listeners gain a data-rich, nuanced perspective on where the market stands and what may unfold next.