Morgan Stanley views the recent market correction not as a reversal of the earnings cycle but as a recalibration tied to the pace of change in earnings revisions and liquidity. In a note to clients, strategist Michael Wilson framed the pullback - led by memory stocks - as "primarily about the peak rate of change in earnings revisions breadth (ERB) for many leading stocks and liquidity."
Wilson described such transitions as typical during earnings-driven bull markets, particularly those with rapid gains. He added that "the earnings bull market remains intact," and Morgan Stanley expects next-twelve-month (NTM) EPS estimates to continue rising through year-end.
What Morgan Stanley is watching
The firm has highlighted three cyclical subgroups it believes are positioned to gain as market leadership broadens. Over the past month, Morgan Stanley notes that Consumer Discretionary Goods, Transports and Regional Banks have already displayed relative strength, rising 9%, 13% and 8%, respectively, compared with a 1% decline in the S&P 500 during the same period.
Despite these moves, the firm cautions that sentiment and positioning toward those groups "remains bearish and muted," implying potential upside if positioning loosens.
Consumer Discretionary Goods
Morgan Stanley points to a shift in household spending from services back toward goods. The firm highlights that goods pricing, at 4.5%, is now outpacing services pricing for the first time since 2022. Correspondingly, earnings revisions breadth for Consumer Discretionary Goods has improved materially - rising to +12% from -9% two months earlier.
Transports
Within Transports, the firm reports an earnings revisions breadth reading of 40%, which it calls "the strongest in four years." Morgan Stanley ties that strength to stabilizing freight volumes and pricing dynamics in the sector.
Regional Banks
Regional Banks are seen benefiting from an environment of strengthening commercial and industrial loan growth and what the firm describes as a broader business-cycle reacceleration. The ISM Composite Index has improved to 54.5, a factor cited in support of that view.
On broader market drivers, Morgan Stanley adds that the contribution of rates, crude and the dollar to equity performance "may now be peaking from a statistical standpoint," a development the firm believes should further enable a wider set of market leaders to emerge.
Bottom line
Morgan Stanley interprets the recent pullback as a routine pause in an ongoing earnings-led advance, and it sees evidence that several under-owned cyclical sectors are already outperforming. The firm continues to expect NTM EPS to rise through year-end, while noting sentiment remains muted across the sectors it favors.