The U.S. 20-year Treasury auction was dismal, with the winning yield breaking above 5%, sparking panic across markets and triggering a dual sell-off in both stocks and bonds.

However, top investment bank morgan stanley turned bullish against the tide, upgrading its ratings on both U.S. equities and Treasuries to “Overweight.” “We hold a neutral stance on global equities and a constructive view on fixed income, but we have a strong preference for the U.S. across all asset classes,” said Morgan Stanley’s team of strategists led by Mike Wilson.

Their bullish scenario projects a 21% rally by June 2026, taking the S\&P 500 to 7,200 points. In the bearish scenario, it could fall to 4,900 points, based on the May 19 closing level of 5,964.

Why the sudden optimism? The Morgan Stanley team explained: “The path of earnings growth by 2026 will be supported by Fed rate cuts, a weaker U.S. dollar, and AI-driven efficiency gains. Moreover, over the past three years, the market has experienced a rolling earnings recession, leaving room for a broader recovery.”

They believe that the tariffs announced on Liberation Day were so extreme that they triggered a capitulation-style decline. As long as a deep recession is avoided, the worst for equities may be over.

Over the next 6 to 12 months, they expect the stock market to focus on a “more accommodative policy agenda,” including infrastructure stimulus, tax cuts, regulatory easing, and Fed rate reductions. A “significant” easing of U.S.-China tensions has lowered recession risks, and Morgan Stanley’s economists now forecast seven rate cuts in 2026, supporting above-average market valuations.

As for near-term risks, the main threat to the stock market is the yield on the 10-year U.S. Treasury note. Morgan Stanley expects yields to remain range-bound through Q4 this year. In the short term, rising long-dated yields will “cap” equity valuations, keeping the S\&P 500 in the 5,500–6,100 range through the first half of 2025, before gradually climbing toward their 6,500 target, Wilson and his team stated.

The primary driver behind the 6,500 target is their forecast of \$302 in forward 12-month earnings per share and a forward P/E multiple of 21.5. That target is more likely to be achieved by mid-2026, given “a substantial pullback in the first half of the year and the lagging earnings impact of tariff uncertainty over the coming quarters.”

In terms of stock selection, Wilson and his team continue to recommend high-quality cyclical stocks—companies with strong management, sustainable long-term returns, and robust balance sheets. They also favor low-leverage, attractively valued equities.

They upgraded the Industrials sector from Neutral to Overweight following Liberation Day, citing it as the most likely beneficiary of renewed focus on domestic infrastructure investment.

The Utilities sector was also upgraded to Overweight, as they reduced exposure to more defensive assets. Additionally, they favor large-cap over small-cap stocks, and U.S. equities over international markets, expecting U.S. corporate earnings forecasts to be revised upward soon.

Morgan Stanley also expects the U.S. dollar to continue weakening, forecasting a 9% drop in the ICE Dollar Index over the next 12 months, as U.S. interest rates and economic growth converge with the rest of the world. In a defensive market environment, safe-haven currencies like the euro, Swiss franc, and yen are likely to outperform.