What’s Fueling Stocks After the AI Trade

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'll be discussing our broadening thesis and the near-term risks to monitor. It's Tuesday, July 14th at 1130 a.m. in New York, so let's get after it. The broadening trade is now playing out. It's showing up in stock prices, relative performance, and earnings revisions. It's also making investors question the sustainability of the most crowded areas of the market and consider other near-term risks. I first made the broadening call late last year based on my view that the economy had entered a new expansion after completing the rolling recession in April of 2025.

0:43Mike Wilson:In a new expansion, earnings growth tends to be much better than expected because the revenue growth returns to companies that have already become more cost-efficient. That's classic operating leverage. The market began to anticipate that dynamic late last year, but then the Iran conflict interrupted the move. Oil surged, rate-cut expectations disappeared, and investors crowded back into the most obvious AI CapEx beneficiaries, led by semiconductors and memory in particular. Since mid-May, that interruption has faded, with oil prices falling sharply and the broadening trade has begun to work again.

1:21Mike Wilson:Importantly, the market is not abandoning AI. It's simply rotating within AI and beyond AI. And that distinction matters. Semiconductors have had a historic run, supported by earnings revisions. But even great stories get exhausted in the short term. When earnings revisions breadth is pressing against historical highs and the trade becomes one of the most crowded areas of the market, the bar for upside gets very high. At that point, the issue is not whether the story is good. The issue is whether the rate of change can keep improving. That's a very different question. The underperformance of the hyperscalers was probably the first warning sign.

1:59Mike Wilson:Semis depend on hyperscaler CapEx. So when the spenders start lagging the beneficiaries, that divergence usually resolves one way or another. And now we're starting to see it. Meta's decision to sell excess capacity to outside customers may not mean the AI CapEx cycle is over, but it does tell you the market is beginning to ask harder questions about the path and pace of that spending. Credit spreads and stock prices of these hyperscalers provide the feedback loop to managements that maybe they should curtail the pace of spend. We've had multiple corrections inside this AI cycle already. This looks like another one, not the end of the cycle, but a reset.

2:38Mike Wilson:That reset is what gives the rest of the market room to work. are preferred ways to express the broadening remain consumer discretionary goods, transports, and biotech. These are not the areas investors have been excited about. In fact, positioning and sentiment remain subdued. But that's exactly why I like them. The risks to the story in the short term are twofold. First, uncertainty about the full reopening of the strait remains high, with pivots on both sides. This is keeping oil prices volatile in the short term, even if the primary trend remains lower. Second, interest rate volatility is picking up again, with the entire curve shifting higher in both nominal and real terms.

3:21Mike Wilson:If this doesn't stabilize, it will have a negative impact on stocks, both at the index level and even for stocks that should benefit from our broadening call. With the inflation data coming in today softer than expected, this should reduce some of the recent upward pressure on rates. However, the new Fed share and board remain resolute to make sure inflation doesn't rear its head again. In the end, dealing with this risk up front is a good thing in my view, even if it means uncertainty for markets. Bottom line, equity markets have been consolidating and correcting for the past several months. This is a result of the peak rate of change in earnings revisions and a reaction function shifted the Fed to focus more on the inflation mandate than growth.

4:03Mike Wilson:With the recent rollover in semiconductors, heavy supply of equity and credit issuance, and a transition of leadership at the Fed, expect more volatility and corrective activity in stocks before the next leg of the bull market resumes. Don't chase momentum. Instead, add to risk on down days to areas that will benefit from a broadening in the economy and earnings growth. 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.

4:43It is not an offer or solicitation, nor is it tax or legal advice. It does not consider your financial circumstances and objectives and may not be suitable for you.