Morgan Stanley: U.S. Stocks Set for "Bullish Setup" in 2026 – Especially Bullish on Small-Caps and Consumer Discretionary

On Monday Eastern Time, Morgan Stanley chief U.S. equity strategist Michael Wilson said that with strengthening leadership, improving earnings, and only moderate labor-market softening, U.S. stocks will enter a "bullish setup" in 2026.

Bullish on Two "Niche" Sectors

Wilson said Morgan Stanley remains optimistic on the prospects for consumer discretionary and small-cap sectors – despite these two sectors not being favored by Wall Street mainstream, the firm firmly believes they will lead market gains next year.

 

Wilson reiterated that since Morgan Stanley upgraded both sectors to "overweight" on November 17, they have "shown relative strength," and he expects this outperformance to continue into next year.

 

For consumer discretionary, the upgrade was driven by multiple factors: stabilizing commodity prices, signs of a shift in spending share from services to goods, improving corporate earnings expectations, the return of an early-cycle environment… lower rates, strong overall household balance sheets, and still-low market sentiment/positioning.

 

He also added that “recent Black Friday sales results exceeded expectations” and “U.S. corporate Q3 revenue results beat expectations… all support our view.”

 

At the same time, Wilson wrote that small caps are poised to benefit from an “early-cycle backdrop,” “stable earnings revisions,” “positive operating leverage,” and “lower rates.”

The Fed Will Be the Key Factor

Wilson said the Federal Reserve remains the key factor for the market’s next move.

 

This week, the Fed will hold its December rate decision meeting and announce its latest call, and since late November, several Fed officials led by New York Fed President Williams have hinted externally that a December cut is possible – which has also driven a recent rebound in U.S. stocks.

 

Wilson said: “From our conversations, many investors expect a ‘hawkish cut’ at this week’s December FOMC meeting.”

 

Wilson stated:

“While we respect this view, we believe it has become consensus. Moreover, we continue to observe that the U.S. labor market is heading toward weakness.”“As we’ve discussed in detail over the past few months, we see a higher likelihood of moderate and lagged weakness in U.S. labor data over the next few months, but a lower likelihood of sharp weakness (i.e., nonlinear rise in unemployment)… this is a bullish setup for stocks.”