MW Morgan Stanley's bold bet: Lower-quality stocks are about to take over

By Jules Rimmer

The New York Stock Exchange is seen during afternoon trading on Aug. 5, 2025, in New York. A tame CPI release on Tuesday could catalyze a shift in market leadership toward small-caps and lower-quality stocks, Morgan Stanley says.

A tame CPI release on Tuesday could catalyze a shift in market leadership toward small-caps and lower-quality stocks. That's the call from Morgan Stanley equity strategist Michael Wilson, whose latest weekly write-up, "Waiting on rate cuts," reinforced his well-entrenched bullish position on stocks.

Wilson's positive view on stocks is generally predicated on rebounding S&P 500 SPX earnings and the supportive cash flow environment. Looking ahead over the next six to 12 months, he's most constructive on industrials, financials and U.S. stocks versus international ones.

While acknowledging inflation risks, Wilson's research led him to believe tariff-induced inflation will peak in August before subsiding later in the year, paving the way for a rate-cutting cycle from the Fed.

If Tuesday's CPI data are relatively benign - consensus is around 0.3% month-over-month - Wilson said the 90% probability of the Fed easing in September will rise. That will create the potential for a more durable rotation into small-caps and stocks of companies with weaker balance sheets and lower profitability. Wilson advised preparing to switch exposure rapidly in the event of a bullish print.

Wilson said that the questions for economists and traders are whether the weakness currently manifesting itself in economic data is bullish or bearish for stocks. The tell for Wilson was that after the weak nonfarm-payrolls number on Aug. 1, the equity market's dip was extremely shallow.

Going forward, Wilson said markets will become conditioned to looking through lagging and weak data releases. He cited the V-shaped recovery in earnings revisions breadth as reflecting corporate confidence and shaping their guidance for expectations.

Earnings revisions breadth, a key indicator for Wilson, continues to improve.

If trading sentiment were to be upset by a hotter-than-consensus CPI figure on Tuesday, Wilson's expectation would be for the megacap/ growth sectors to maintain market leadership. Within sectors, Morgan Stanley had doubts that the consumer-goods companies have pricing power given tariffs, but industrial will. He preferred the latter.

Adding further weight to Wilson's constructive approach is the strength of corporate earnings, as earnings-per-share surprises are running +8% while revenues are +3%, both above historical averages. Wilson pointed to the importance of earnings-revisions breadth, which continues to improve from -25% to plus 16%.

2026 estimates are slowly ticking higher again.

-Jules Rimmer

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August 11, 2025 10:43 ET (14:43 GMT)

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