Morgan Stanley’s US equity team, led by Michael Wilson, has reiterated an optimistic outlook on the US equity market. The team anticipates a return of positive operating leverage, driven by pent-up demand and reduced labour cost growth. This, they say, sets the stage for an acceleration in earnings per share (EPS) growth in 2026, a phenomenon typically seen in the early stages of an economic cycle.
Despite investor concerns about a potential resurgence of inflation next year, the Morgan Stanley team believes that a return of pricing power would be beneficial for earnings, similar to the situation in 2021. They argue that inflation is positively correlated with both top-line and bottom-line growth, and expect the Federal Reserve in 2026 to be more tolerant of such an outcome. Wilson addressed client concerns about valuations, noting key differences between the current market and the late 1990s.
According to Wilson, free cash flow yield for the median large-cap stock is significantly higher now than it was in 2000. Furthermore, the market multiple, when adjusted for profit margins, appears more reasonable today, trading at a substantial discount compared to that period. The team emphasises that current free cash flow generation, operational efficiency, and strong profitability indicate a higher quality index overall.
Wilson also added that the anticipated macro/earnings environment in 2026 supports current valuations. Their ‘run it hot’ thesis suggests that structurally higher inflation makes equities and gold key inflation hedges. Consequently, equity prices relative to gold are significantly below their 1999 peak, suggesting stocks are a relatively cheaper inflation hedge. Morgan Stanley intends to further discuss this perspective in the coming months.
