The investment firm has lifted its year-end target for the S&P 500 to 8,000 in its new outlook, arguing the market has already priced in the biggest risks.
On the other hand, the rate path of the US Federal Reserve’s (Fed) under new leadership and even higher crude prices posed the biggest risks to its base case.
Joining the chorus of other Wall Street forecasts coming out this week, Morgan Stanley has bumped its year-end target for the US index to 8,000 from 7,800 to now match Deutsche Bank, some 7 per cent higher than its current level. Its 12-month target to mid-2027 has also been raised to 8,300.
It comes as the S&P 500 finished 12 May at its second-highest level ever of 7,400.96, having gained 17 per cent from its end of March low.
In an outlook produced by equity strategist Mike Wilson and colleagues, the team argued that the first half of this year has ultimately felt much like the first half of last year.
“In several respects, the path of equities over the past few months has followed a script we’ve seen many times – markets weakening under the surface well ahead of the headlines, many focusing on the “new” risk after prices have already adjusted, and sentiment deteriorating just as the forward setup is quietly improving,” the strategists said.
While the team argued that much has been made of the fact that the S&P 500’s decline was less than 10 per cent on a price basis at the March lows, they said that view overlooks the significant reset in valuations and breadth that also occurred.
Wilson and his analysts pointed to roughly half of stocks in the broader Russell 3000 that saw drawdowns of 20 per cent or more, while the S&P 500’s forward P/E multiple compressed by 18 per cent from its peak as forward earnings continued to surge even throughout the war.
“That’s not complacency, in our view, but a market that did a substantial amount of work to price in the numerous risks that appeared over the past 6 months – Iran war/oil spike, AI disruption and private credit concerns being the most significant,” the strategists wrote.
They added that in the areas of the market more directly affected by these risks, over 40 per cent corrections often took place.
On the elevated oil price, they downplayed the spike as less significant than other major historical episodes in both nominal and real terms so far, arguing that the global economy is more resilient and better able to absorb supply disruptions than many might assume.
“In short, the bar for an oil-driven recession/significant growth scare is much higher in the current environment than in prior oil price shocks. It would likely require not just a sustained move in crude above [US]$130-150 per barrel, but also a meaningful deterioration in earnings trends – neither of which we see as our base case.”
The comments also followed those of ClearBridge’s managing director and head of market strategy Jeffrey Schulze, whose similarly bullish view on US equities rested on expectations of a resolution to the Iran war by early June.
Morgan Stanley attributed its constructive outlook on US equities over the past 12 months to a rebound in earnings growth, which it expects will continue, noting that the strength extends beyond the hyperscaler and semiconductor sectors.
Specifically, they noted that Q1 EPS surprise for the median S&P 500 stock is 6 per cent, the strongest it has been in four years. In addition, the S&P 600 Small Cap Index forward EPS growth is 22 per cent, up from 8 per cent at the start of the year.
On sector preferences, the firm said it favoured industrials, financials, and consumer discretionary goods, while continuing to view the hyperscalers as an attractive relative value trade and moving healthcare to equal weight.
Key risks
At the same time, Wilson and his team acknowledged that risks remain, pointing to the shift in central bank policy towards a less dovish stance since the start of the year as a key change.
The US Senate has this week confirmed Kevin Warsh as Federal Reserve (Fed) chair, replacing Jerome Powell, with Warsh set to take up the role on 14 May US time. The strategists noted that Warsh alluded to a “patient approach” around further rate cuts at his Senate confirmation hearing.
“The good news is that we don’t need rate cuts to achieve our multiple target which is slightly below current levels,” the strategists wrote.
However, this formed the central element of their bear-case scenario, which sees the S&P 500 falling to 5,900 over the next 12 months if the Fed is forced to take a more hawkish stance on rates due to a resurgence in inflationary pressures.
Its bull case, with a 9,400 price target, hinges on earnings expansion exceeding its base case, with AI players continuing to drive momentum.
“[The bear case] scenario is very unlikely to play out before year end but ironically its probability increases if our bull case plays out in the second half of this year and an inflation impulse lags a historic demand recovery.”
