Source: Sharecast
The bank said it expects European equities to be "pulled into the slipstream of a broadening US recovery in 2026, despite continued domestic fiscal challenges and structurally rising China competition".
It upgraded both European utilities and food retail to ‘overweight’ from ‘equalweight’. It also upgraded semi and metals & mining to ‘equalweight’ from ‘underweight’ and downgraded business services and telecoms to ‘equalweight’ from ‘overweight’.
Discretionary retail was downgraded to ‘underweight’ from ‘equalweight’.
Morgan Stanley said banks top its refreshed model, remaining at ‘overweight’.
The bank lifted its MSCI Europe December 2026 target to 2,430 from 2,250 previously, and versus a current level of 2,303, driven by strong earnings growth.
In the same note, it also said it now expects the S&P 500 to hit 7,800 by December 2026, which is around 16% upside from current levels.
The S&P call is based on above-consensus earnings growth driven by positive operating leverage, AI-driven efficiency gains, growth-positive tax and regulatory policies, and, as a result, broadening leadership.
In terms of US equities, Morgan Stanley upgraded small caps to ‘overweight’ from ‘underweight’. The bank noted it’s been underweight small caps for the vast majority of the past four years, having removed its 'overweight' rating in March of 2021 following a strong period of outperformance post-Covid and before a multi-year run of underperformance.
"What gives us conviction to upgrade the group to overweight now? The main reason is tied to our out of consensus view that we're now entering an early cycle environment following the rolling recession of 2022-early 2025," it said.
"To recap, we believe the four key pillars of an early cycle set-up are with us today, a combination of variables that uniquely support small cap outperformance. These four elements are: compressed cost structures that set the stage for positive operating leverage to resume, pent up demand, a historic rebound in EPS revisions breadth and a Fed that is cutting rates. Early evidence suggests the small cap earnings recovery is underway."
At the sector level, consumer discretionary goods were lifted to ‘overweight’ from ‘underweight’, while healthcare remains the bank’s preferred exposure to "quality growth". It upgraded the sector to ‘overweight’ from ‘equalweight’.
"Healthcare benefits from rate cuts into 2026, supportive earnings momentum, undemanding valuations, lessening policy overhangs and M&A tailwinds," it said. "Biotech, in particular, tends to see strong relative performance 6–12 months post the first Fed cut, though the sector overall sees relative outperformance."
