Famous "big short": US stocks will continue to rebound, except for small-cap stocks!

Morgan Stanley's Mike Wilson stated that the rebound of the U.S. stock market after the election should continue, with some exceptions. Futures in early trading on Monday indicated that the S&P 500 index would attempt to break through the 6000-point mark again, after briefly surpassing this threshold last Friday, marking the 50th historical high of the year. Trump's re-election has clearly given more confidence to the bulls. In just the past four days, the S&P 500 index rose by 4.95%, as investors flocked to the market segments they believe will benefit the most from Republican policies. Morgan Stanley's Chief U.S. Equity Strategist Mike Wilson believes that there is further upside potential for this trade. However, he is more cautious about small-cap stocks than many others. Wilson and his team wrote in a report on Monday: “We see high-quality cyclical stocks continuing to rise, as expectations for a rebound due to a more lenient regulatory environment, supportive tax policies, and potential animal spirits should increase following last week’s (election) results.” In fact, Wilson emphasized that as the macroeconomic backdrop becomes more favorable for cyclical sectors to outperform, political progress is also coming along, with the Federal Reserve recently cutting interest rates and economic activity indicators improving. Wilson is particularly optimistic about financial sector ETFs, which have rebounded due to accelerating capital market activity, relatively low valuations, and investor positioning. Positive earnings revisions have also played a role. He stated, “Now that we have the results of the presidential election, it seems that expectations for deregulation are also driving performance up, in addition to the improvement in fundamentals,” and he maintains his overweight rating. Wilson acknowledged that there are three risks to the cyclical stock narrative. First, even though the Federal Reserve is cutting interest rates, an increase in bond term premiums (possibly stemming from concerns about fiscal sustainability) could lead to a significant rise in yields. Then, “stock valuation multiples may face resistance,” he said. Second, according to Wilson, if the dollar continues to strengthen at its current pace until the end of the year, it could slow down earnings growth for multinational companies. “This may be felt more acutely in large-cap indices (which tend to have higher overseas sales exposure) than in ordinary stocks, which is why even if the dollar proves to be a headwind, this expansion will continue beneath the surface.” He noted that domestic-oriented sectors, such as financials, will be less affected. The third risk is overvaluation. “In recent months, the price movements of the S&P 500 index have become disconnected from the fundamentals,” Wilson said. “More specifically, the year-on-year changes in the S&P 500 index have rarely been so disconnected from the breadth of earnings revisions.” But even without all these considerations, Wilson remains cautious about small-cap stocks. Looking at the script from 2016, after Trump won the election, it indicated that small-cap and low-quality stocks might outperform for a period post-election, but Wilson believes there are some differences to consider compared to 2016 He said, "First of all, several sectors in these markets are currently showing a negative correlation with interest rates, whereas they exhibited a positive correlation in 2016. In other words, in today's late-cycle environment, these groups are more adversely sensitive to rising interest rates than they were back then." Wilson indicated that if U.S. Treasury yields rise further, small-cap stocks may perform poorly, as the relative earnings revision breadth for small-cap cyclical stocks is currently negative, while it was positive in 2026. "Finally, even though animal spirits rose after the 2016 election, the relative performance of small-cap stocks peaked in early December of that year, just a month after the election," he added