A Good Time to Buy the Dip?

0:00Mike Wilson:Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley CIO and Chief U.S. Equity Strategist. Today on the podcast, I will discuss what's driving my optimism on stocks. It's Tuesday, July 29th at 1130 a.m. in New York, so let's get after it. Over the past few weeks, I've been leaning more toward our bull case of 7 ,200 for the S &P 500 by the middle of next year. This view is largely based on a more resilient earnings and cash flow backdrop than anticipated. The drivers are numerous and include positive operating leverage, AI adoption, dollar weakness, cash tax savings from the big beautiful bill, and easy growth comparisons and pent-up demand for many sectors in the market.

0:46Mike Wilson:While many are still focused on tariffs as a headwind to growth, our analysis shows that tariff cost exposures for the S &P 500 industry groups is fairly contained given the countries in scope and exemptions that are still in place from the USMCA. Meanwhile, deals are being signed with our largest trading partners like Japan and Europe that appear favorable to the U.S. Due to the lack of pricing power, the main area of risk in the stock market from tariffs is consumer goods, and that's why we remain underweight that sector. However, the main tariff takeaway for investors is that the rate of change on policy uncertainty peaked in early April.

1:25Mike Wilson:This is the primary reason why earnings guidance bonded in April, as evidenced by the significant inflection higher in earnings revision breadth, the key fundamental factor that we've been focused on. Of course, the near-term setup is not without risks. These include still high long-term interest rates, tariff-related inflation, and potential margin pressure. As a result, a correction is possible during the seasonally weak third quarter, but pullbacks should be shallow and bought. In addition to the growth tailwinds already cited, it's worth pointing out that many companies also face very easy growth comparisons.

2:03Mike Wilson:I've had a longstanding out-of-consensus view that the U.S. has been experiencing a rolling recession for the last three years. This fits with the fact that much of the soft economic data has been hovering in recession territory for much of that period as well. Things like purchasing manager indices, consumer confidence, and the private labor market. It also aligns with my longstanding view that government spending has helped to keep the headline economic growth statistics strong, while much of the private sector and many consumers have been crowded out by that heavy spending, which has also kept the Fed too tight.

2:38Mike Wilson:Meanwhile, private sector wage growth has been in a steady decline over the last several years, and payroll growth across tech, financials, and business services has been negative until recently. Conversely, government and education health services payroll growth has been much stronger over this time horizon. This type of wage growth and sluggish payroll growth in the private sector is typical of an early cycle backdrop. It's a key reason why operating leverage inflects in early cycle environments and margins expand. Our earnings model is picking up on this underappreciated dynamic, and AI adoption is likely to accelerate this phenomenon.

3:18Mike Wilson:In short, this is looking more and more like an early cycle setup, where leaner cost structures drive positive operating leverage after an extended period of wage growth consolidation. Bottom line, the capitulatory price action and earnings estimates cuts we saw in April of this year around Liberation Day represented the end of a rolling recession that began in 2022. Markets bottom on bad news, and we are transitioning from that rolling earnings recession backdrop to a rolling recovery environment. The combination of positive earnings and cash flow drivers with the easy growth comparisons fostered by the rolling earnings recession and the high probability of the Fed restarting the cutting cycle by the first quarter of next year should facilitate this transition.

4:05Mike Wilson:The upward inflection that we're seeing in earnings revision breadth confirms this process is well underway and suggests returns for the average stock are likely to be strong over the next 12 months. In short, buy any dips that may occur in the seasonally weak quarter of the year. Thanks for tuning in. I hope you found it informative and useful. Let us know what you think by leaving us a review. And if you find thoughts on the market worthwhile, tell a friend or colleague to try it out. The preceding content is informational only and based on information available when created. It is not an offer or solicitation, nor is it tax or legal advice.

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