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1. Morgan Stanley says the new 'bull case' for stocks is emerging.

“It follows a rebound driven by a "near complete reversal on 'reciprocal tariffs' and a successful de-escalation of trade tensions with China within the last 30 days.

According to Morgan Stanley, this emerging "bull case" is premised on several key beliefs.

First, the "belief that tariffs are a non-event, manageable unknown," and secondly, the "belief that 2025 earnings don't matter," with "earnings revisions for 2026 turning less negative," and a weak U.S. dollar seen as a positive.

Furthermore, there is the "belief that inflation risks are over-estimated, low oil prices a tailwind, the Fed will commence rate cutting soon, corporate tax cuts" driving a "capex and productivity boom," and the conviction that "Gen AI is in the very early innings."

Morgan Stanley notes that "2026 S&P 500 earnings are expected to show accelerating growth from 2025's 7-8% to 13-14%." However, they also caution that the recovery of equity valuations has pushed the price-to-forward earnings ratio above "21.5x," and the "equity risk premium sits at a paltry 6bps."

Risks are said to include steepening "Global yield curves" and widening U.S. budget deficits, which Morgan Stanley views as a potential "headwind to American Exceptionalism."

Here are the forward P/E ratio’s for the S&P.

2. So what is the problem with the equity risk premium?

The equity risk premium, which investors use to determine the difference between expected returns on equities and US Treasuries, is hovering around its lowest point since 2002, data from Bloomberg Intelligence showed.

That suggests stocks are more expensive relative to bonds than they have been for most of the last two decades, according to Bloomberg Intelligence strategists Gina Martin Adams and Michael Casper. Calculated by subtracting the S&P 500 Index’s earnings yield from the 10-year Treasuries rate, the gauge helps investors decide where to allocate their cash.

The case for owning equities becomes less compelling if bonds can earn nearly as much as stocks but with reduced risk.

After the big recovery in stocks since April, the readout is fairly gloomy for equities: The S&P 500 has averaged a 12-month return of only 2.5% over the past three decades when the risk premium has stood around current levels, according to data compiled by investment research firm CFRA.

“Whenever you see equity risk premium slump this much, it historically tells us that stocks are becoming less attractive,” said Timothy Chubb, chief investment officer at Girard, a wealth advisory firm backed by Univest. “After a massive rally over the past two months, this could take some air out of the recent rebound.”

3. Some parts of the market are starting to look stretched, such as cyclicals.

They are pricing significant economic improvement, which may happen down the line, but it’s a view that’s vulnerable to downside risks.

UBS strategists led by Andrew Garthwaite see plenty of reasons to be cautious, beyond geopolitics.

They say the ratio of returns on cyclicals — ex-tech and financials — over defensives is pricing in a sharp rise in PMIs and positive economic surprises.

However, they expect US GDP growth to slow from 2.1% year-on-year in 1Q to 0.9% in 4Q, while soft data has weakened sharply in the US and recession indicators have ticked up.

Meanwhile, the cohort screens as expensive against defensive peers, is priced for a sharp rise in earnings revisions and has become crowded, the strategists add. “The time to buy cyclicals is when implied intra-index volatility is high and cyclicals are oversold — neither condition is met currently,” they say.

4. Rotation into defensives has a lot of room to expand.

5. Gold Is the real rival to the Dollar’s reserve status.

Central banks snapped up gold at a record pace last year, putting the safe-haven metal ahead of the euro as the second-most popular reserve asset. A report issued Wednesday by the European Central Bank highlighted the shifts underway in the portfolios of global central banks.

Reserve managers bought 1,000 metric tons of gold, double the pace of the previous decade. A price rally also helped lift gold's portion of total reserves to 20%.

Central banks have pared back dollar holdings in recent years, with the currency's share of all reserve assets falling to 46% last year.

Source: WSJ

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