The stock market surprised many when it bottomed in early April following a sharp tariff-driven sell-off.
President Trump's higher-than-hoped tariffs caused investors to reset their outlooks for economic growth lower, ratcheting down corporate and revenue estimates.
While the risk remains that inflation will increase because of newly instituted tariffs, his decision to pause instituting the harshest reciprocal tariffs on April 9 was enough to spark a rip-roaring oversold rally, catapulting the S&P 500 and Nasdaq Composite 25% and 32% higher, respectively.
The gains erased the 19% near-bear market drop in the S&P 500 this spring, leading to new all-time highs for the benchmark index.
💵💰Don't miss the move: Subscribe to TheStreet's free daily newsletter💰💵
Undeniably, the stock market has climbed a steep wall of worry, and investors are right to wonder if the S&P 500 has enough gas in the tank to continue higher.
Morgan Stanley's Chief Investment Officer, Mike Wilson, addressed that question, recently updating the odds that the S&P 500 will be higher in 2026.
Image source: TheStreet
Stocks latch onto ‘not bad' economic data
President Trump has said there won't be more extensions on paying tariffs after August 1.
Still, a willingness to back off the highest proposed tariffs from April appears to remove the worst-case scenario of an economic reckoning—a recession—from the table for now.
Related: Analyst resets S&P 500 forecast for rest of 2025
The likelihood that the economy sidesteps a reckoning improved further in July when President Trump signed trillions of dollars in tax cuts into law through the One Big Beautiful Bill Act.
The stimulus from tax cuts could offset some slowing associated with an uptick in inflation caused by tariffs, assuming any tariff-driven inflation is, dare I say it, tame and transitory.
Regardless, an improved economic outlook from April has emboldened stock investors, particularly since most believe that the Federal Reserve will provide additional support.
So far, the Fed has remained neutral in 2025. However, the Fed's June forecast suggests two rate cuts by year's end, and most on Wall Street expect more cuts in 2026.
If so, Big, Beautiful Act stimulus plus dovish rate cuts that put more money in pockets could help corporate revenue and earnings improve, supporting the S&P 500's rich valuation.
Currently, the S&P 500's forward price-to-earnings ratio is above 22.2, according to FactSet. That's historically high, given the 5-year and 10-year average forward P/E is 19.9 and 18.4.
Analyst revamps S&P 500 outlook for 2026
Stock prices are forward-looking and are considered a leading rather than lagging indicator because they aggregate the opinions of all market participants.
So far, the stock market doesn't appear worried about the prospect of GDP-busting inflation dinging corporate profits, something that has Morgan Stanley's Mike Wilson increasingly optimistic.
Related: The stock market is being led by a new group of winners
“An underappreciated aspect of the earnings story into 2026 is that positive operating leverage is returning from lower wage costs (in part). This is
driving upside in our earnings models,” wrote Wilson in a research note. “Thus far, we're also not hearing a significant level of
concern from corporates across the index in terms of tariff-related costs impacting
margins.”
Wilson acknowledges that could change as we push through earnings season, but generally, he seems to believe that earnings upside may justify stocks' lofty valuations, especially given that Morgan Stanley expects significant Fed interest rate cuts next year.
“S&P 500 EPS revisions breadth continues to accelerate higher (now +7%, up from -25% in
April), helping to confirm our constructive view on the earnings backdrop post the
Liberation Day capitulation,” wrote Wilson. “With
earnings on solid footing into next year for the overall market and the Fed set to cut rates
7 times through YE 2026 (according to our economists), we think valuation will also
remain supported around current levels (~22x).”
With earnings revisions trending the right way, improving the “e” in the P/E ratio, the S&P 500 has a better shot at heading higher next year, prompting Wilson to up the odds for more gains. Particularly, given additional tailwinds from a lower US dollar, which provides help with currency conversion on overseas sales.
More on stocks:
- Veteran fund manager who forecast Nvidia stock rally reboots outlook
- Billionaire Ackman has one-word message on stock market
- Legendary fund manager reveals new trades after S&P 500 rally
According to FactSet, second-quarter net profit margins for S&P 500 companies are estimated to be 12.3%, above the five-year average of 11.8%. Wall Street analysts project earnings growth of 9.3% in 2025 and 14% in 2026.
“The
[US Dollar Index] DXY is down about 10% from the January highs and has another 7-8% to go into the
middle of next year according to our FX strategists. This should offer further support for
US relative earnings revisions versus rest of world,” wrote Wilson. “Between retail sales and the
Philadelphia Fed Manufacturing survey, macro data last week also appeared to suggest
that the demand backdrop is holding up better than many expected.”
Overall, the improving backdrop makes it more likely that the S&P 500 trades above 7,000 in 2026.
“Bottom line, we're leaning more toward our bull case of 7200 for the S&P 500 by the
middle of next year,” concludes Wilson.
Related: Legendary fund manager has blunt message on ‘Big Beautiful Bill'
