Market Rally: Can Earnings Keep It Going?

Earnings strength and a more supportive Federal Reserve should help sustain market valuations, says Morgan Stanley strategist Mike Wilson.

Investors continue to buy the dips. S&P 500 futures opened the week 1.5% above Friday’s intraday low, reflecting a still-bullish tone.

In a Monday note, Wilson and his team raised their 12-month S&P 500 target to 7,800, up from a prior 7,200 forecast for mid-2025. From current levels, that implies roughly 16% upside. Even if the index tops 7,000 this year, Morgan Stanley still expects double-digit gains through 2026.

Wilson sees next year’s economy benefiting from growth-positive catalysts such as tax cuts and deregulation, reversing the drag from tariffs and government job reductions.

“A new bull market and rolling recovery began in April, which means it’s still early days,” Wilson writes. “It may not look obvious yet, especially in lagging areas of the economy and market.”

This backdrop supports a healthier earnings outlook. Morgan Stanley expects companies to gain from positive operating leverage, stronger pricing power, and AI-driven efficiency improvements. Recent data backs that up: third-quarter results showed a 2.2% revenue beat rate for the S&P 500 — double the average — and 8% median EPS growth for Russell 3000 stocks, the fastest in four years.

The bank now forecasts S&P 500 EPS of $272 in 2025 (12% growth), $317 in 2026 (17% growth), and $356 in 2027 (12% growth).

Monetary policy is another tailwind. Wilson believes markets are underestimating how accommodative the Fed will be over the next 6–12 months. He expects softer labor data and a willingness from policymakers to “run it hot” to result in a looser stance on both rates and the balance sheet.

While Wilson anticipates a slight contraction in the market’s P/E multiple — from about 22.3 to 22 — he notes that strong earnings growth and easy monetary policy rarely trigger meaningful valuation compression.

Despite underperformance this year — the Russell 2000 ETF has lagged the S&P 500 by roughly 7 percentage points — Wilson expects leadership to broaden. He is upgrading small caps to overweight, citing improving earnings revisions relative to large caps.

Wilson is also shifting sector preferences. Morgan Stanley now favors consumer discretionary goods stocks — including Amazon, Dick’s Sporting Goods, AutoNation, and Wayfair — over services. He notes that earnings revisions in goods are improving, and the long-term performance ratio between goods and services is near historic lows and starting to turn higher.

The firm also reiterates its overweight view on financials, and upgrades healthcare to overweight as its preferred “quality growth” sector.