Trying to predict where the broader benchmark S&P 500 index will land in 12 months is one of the toughest jobs on Wall Street. Nobody can predict the future, and 12 months is a relatively short period of time. It's also riskier for strategists to be bearish, as more strategists will lose their jobs for missing a market rally than for failing to see a market correction.
However, in 2022, Morgan Stanley's Chief Market Strategist, Mike Wilson, became bearish on the stock market, while many strategists were still riding the late-cycle COVID-19 wave. Wilson nailed his call, as the S&P 500 fell close to 20% that year. Recently, Wilson and his team came out with a new price target for the S&P 500 -- and it may surprise you.
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Strong corporate earnings can push up valuations
Wilson has now been bullish since earlier this year. He believes that a new bull market and a "rolling recovery" began in April, and thinks it's still in the early stages. Primarily, Wilson and his team are bullish on corporate earnings, which they think will be driven higher by factors including positive operating leverage, increased pricing power, and efficiency gains fueled by artificial intelligence:
Our forecasts reflect this upside to earnings which is another reason why many stocks are not as expensive as they appear despite our acknowledgement that some areas of the market may appear somewhat frothy -- i.e., certain unprofitable, speculative growth areas.
Morgan Stanley estimates that the S&P 500 collectively beat Wall Street's revenue estimates by 2.2% in the third quarter, double the average. The bank also calculated 8% median earnings-per-share growth for the Russell 3000, the strongest growth seen in four years. Wilson and his team also believe that the S&P 500 can collectively continue to grow earnings. They expect the benchmark index to register 12% year-over-year growth this year, 17% next year, and 12% in 2027.
The market is more doubtful about another interest rate cut from the Federal Reserve in December. But as of this writing, Wilson thinks the market is underestimating just how dovish the Fed will become, considering a weakening labor market and President Donald Trump's administration's wish to "run it hot," in reference to the economy. This is likely to lead to both rate cuts and help from the Fed's balance sheet, according to Wilson.
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Key Data Points
Wilson is raising his S&P 500 price target from 7,200 earlier this year to 7,800 one year from now, implying about 18% upside from current levels. This also suggests using a 22 times forward multiple on Wilson's S&P 500 2027 earnings per share estimate of $356.
While Wilson acknowledges that pockets of the market seem frothy, he and his team also noted that it's unusual to see the S&P 500 earnings multiple contract when the index is experiencing higher EPS growth and monetary easing. In terms of what he likes, Wilson upgraded small-cap stocks ahead of large-cap stocks and also remains overweight on the financials and healthcare sectors.
Long-term investors need to be patient and smart
Long-term investors must do their best to ignore the day-to-day market drama and stay the course. Historical data suggests that the longer one holds one's investments, the less likely they are to lose money.
The reality is that many are torn between whether the market can continue to move higher or if we are in some kind of AI or asset bubble. It's impossible to predict, and you shouldn't try to time the market. Retail investors can be smart by continuing to employ investment strategies such as dollar-cost averaging, which will smooth out their cost basis over time.
For stock pickers, Wilson's idea of financials and healthcare is a good place to start, as both sectors have more reasonable multiples than some of the frothier parts of the market. Healthcare stocks trade at relatively low multiples and may benefit from increased regulatory clarity in the coming years. Financials are also trailing the broader market, yet are quite profitable, still seeing good credit metrics, and are set to benefit from deregulation.
