Rolling Recovery Thesis Opportunity

Our CIO and Chief U.S. Equity Strategist Mike Wilson explains why investors might want to reassess their portfolios, keeping in mind the gap between market moves and monetary policy.

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Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief U.S. Equity Strategist. Today on the podcast, why the Fed may hold the key for both near term and medium-term stock market performance. 

It's Monday, November 24th at 1pm in New York. 

So, let’s get after it. 

At the end of September, we discussed the building tension between the Fed and markets in terms of both the fed funds rate and liquidity, suggesting this had the potential to lead to a correction in the short-term. This scenario is playing out with high momentum and low-quality stocks responding more to tightening liquidity back in September, while the high-quality S&P 500 and Nasdaq 100 responded more to the incremental hawkishness on rate cuts relayed at the October 29th Fed meeting.

While downside for the S&P 500 has been limited to just 5 percent, the damage under the surface has been more significant with two-thirds of the largest 1000 stocks seeing more than a 10 percent drawdown and one quarter down more than 20 percent. Similarly, Bitcoin is down close to 30 percent and topped even earlier than high momentum stocks. Gold also felt the impact of tighter liquidity earlier than the S&P 500, as one would expect.

We’re staying vigilant around this dynamic related to monetary policy and can't rule out more index-level downside in the short-term, especially if breadth remains weak. Having said that, we think the weakness under the hood is a sign that we're closer to the end of this correction than the beginning for the weaker areas of the market. Historically, the Generals tend to fall the most at the end of corrections. As I said on this podcast back in September, we would view this type of correction and reset on expectations as an opportunity to double down on our rolling recovery thesis which remains out of consensus.

From our perspective, private labor data are showing signs of weakness that suggest the Fed should be cutting rates more aggressively. This is very much in line with my core view that the rate of change trough in the labor data occurred back in April with the lows in the equity market. The official government labor data that the Fed is waiting for is lagging and will simply confirm what we, and the markets, already know. With the official October jobs data cancelled due to the shutdown and the November series not available until December 16th, the equity market may continue to wrestle with the Fed that dragging its feet and delaying rate cuts.

The good news is that we expect a meaningful decline in the Treasury’s General Account in the coming weeks as the government re-opens. This should help to provide a much-needed boost to liquidity at the same time the Fed ends quantitative tightening. The question is whether these changes will be enough to improve liquidity conditions in a durable way. In my view, the clearest indication will be if we see relief in areas of the equity market and asset classes most sensitive to these dynamics over the next two weeks. That means low quality profitless growth stocks in the equity world should rally the most.

Bottom line, I remain convinced in our bullish 12-month outlook for the S&P 500 and stocks more broadly. Initial feedback from investors to our recently published 2026 outlook indicates that several of our core views for 2026 remain out of consensus. More specifically, our early cycle narrative versus consensus thinking that we’re late cycle; 17 percent earnings growth next year versus the consensus at 14 percent. And finally, our upgrades of small/mid cap stocks and consumer discretionary goods to overweight. Use near term weakness related to a Fed that is moving too slow for the markets’ liking to reposition portfolio to sectors and stocks that have lagged behind for most of the past several years – but will benefit the most from the more aggressive Fed action that we expect to come.

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!