Morgan Stanley's U.S. equity strategy report released in June 2025 noted that although the market faced policy tightening pressures in the first half of 2025, the second half of the year through 2026 would enter a more optimistic scenario for U.S. stocks.

Looking ahead to 2025, the bank believes that policies at the beginning of the year may lean toward risk aversion, leading to more challenges in the first half, while the second half of 2025 and 2026 will shift to a more positive environment. Given that equities tend to focus on expectations for the next 6–12 months, the market is currently anticipating a more accommodative policy agenda for stocks during the bank's forecast period.

The bank's economists do not foresee a recession in their baseline forecast but expect seven rate cuts in 2026, which will support above-average valuations.

The bank maintains its 12-month target for the S&P 500 at 6,500 points, corresponding to earnings per share (EPS) of $302 and a forward price-to-earnings (P/E) ratio of 21.5x. It forecasts EPS of $259 for 2025 (7% growth), $283 for 2026 (9% growth), and $321 for 2027 (13% growth).

The earnings trajectory will benefit from the Fed's rate cuts in 2026, a weaker U.S. dollar, and the broad realization of efficiency gains driven by artificial intelligence (AI).

The bank believes valuations will remain elevated at 21.5x, with strategists noting that in an environment of above-median EPS growth and declining interest rates (the bank's baseline expectation for mid-next year), the likelihood of valuation compression is low.

Based on the policy cycle and industry trends, Morgan Stanley has proposed corresponding strategies for different sectors:

Overweight Sectors: The bank assigns overweight ratings to financials, energy, and utilities.

Financials: The bank believes that due to slowing GDP growth and rising economic uncertainty, mergers and acquisitions (M&A) and capital markets deal flow will be delayed but expects normalization by 2028. In the near term, 2025 could see potential regulatory easing, which may lead to a significant acceleration in stock buybacks.

Energy: The sector's relative performance is once again linked to crude oil price movements, reflecting the current relatively low oil prices. With policy uncertainty high, geopolitical tensions remain elevated and could disrupt oil supply, driving prices higher. Additionally, the sector's free cash flow (FCF) margins remain well above historical averages, the net debt-to-EBITDA ratio is still below its long-term trend, and hedge funds (HF) appear to be underweight in the sector.

Utilities: The sector has a historical track record of strong performance in the late cycle, as its defensive attributes tend to outweigh interest rate sensitivity at this stage. Utilities are beneficiaries of the generative AI (GenAI) theme and stand to gain from rising interest rates and increased focus on energy capacity.

Neutral Sectors: Technology, healthcare, communication services, materials, real estate, healthcare, and industrials remain at market weight.

Within the technology sector, performance is highly bifurcated, with AI-related stocks (e.g., semiconductors, software) outperforming due to surging computing demand, while hardware is weighed down by weak consumer spending. The healthcare sector is defensive but shows slowing earnings growth momentum.

Underweight Sectors: Consumer discretionary and consumer staples are rated underweight, based on their poor pricing power, tariff risks, and weaker earnings revisions compared to the consumer services sector. Tariff uncertainty continues to weigh broadly on the consumer goods sector.

Consumer goods face tariff risks. Consumer credit analysts note that for retail or branded companies, product costs can account for 50%–80% of the total cost of goods sold (COGS). Tariffs create an EBITDA headwind for companies in this sector, averaging between 10% and 70%. Firms are facing a more challenging pricing environment while continuing to grapple with cost pressures from labor and COGS.