Michael Wilson Weekly Warm up Broadening Continues as Index Struggles

US Equity Strategy | North America Morgan Stanley & Co. LLC Idea

Michael J Wilson Equity Strategist

Equity Strategist Our broadening thesis continues to play out as the index Diane Ding, Ph.D. Quantitative Strategist struggles to make headway and former leaders correct. This

leadership change is likely to persist and may lead to further Nicholas Lentini, CFA Equity Strategist consolidation in major indices before the bull market resumes in

earnest. Focus on EPS quality at the factor level. • Our Broadening Thesis Continues to Play Out...The Equal Weighted S&P 500 has continued to outperform the Cap Weighted S&P, while Consumer Discretionary Goods and Transports have each outperformed the S&P 500 by 12% over the past two months. We continue to see support from accelerating earnings growth across the median stock, expanding Artificial Intelligence adoption, lower expected oil prices, and a Federal Reserve that remains on hold. • ...As Semis Underperform...A month ago, we argued that the momentum trade and Semiconductors, in particular, were due for a pullback as earnings revisions breadth reached historical extremes, price action reflected commodity-like volatility, and positioning became increasingly concentrated and driven by leverage. While we would not be surprised to see a bounce in Semis given the 20%+ correction already experienced, we continue to expect market leadership to broaden beyond the space and across a wider range of industries in the second half. In other words, the momentum unwind is helping to fuel the broadening into areas where strong EPS revisions are underappreciated—particularly Consumer Discretionary Goods and Transports. • We Still Like the Hyperscalers Versus Semis Over the Next Several Months...That said, we acknowledge that the risk/reward is less attractive after nearly 30% of relative outperformance in just 3 weeks. While our factor work suggests the market is placing renewed emphasis on capex discipline, we believe the hyperscalers were early in discounting both this shift and the market's focus on peaking capex growth. Further, they retain compelling AI optionality through strong core businesses, leadership potential in the agentic application layer, and an underappreciated cost- efficiency lever. As the AI cycle evolves, we expect continued rotations in relative performance across different AI beneficiaries, consistent with the pattern observed over the past several years. Morgan Stanley does and seeks to do business with companies covered in Morgan Stanley Research. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of Morgan Stanley Research. Investors should consider Morgan Stanley Research as only a single factor in making their investment decision. For analyst certification and other important disclosures, refer to the Disclosure Section, located at the end of this report.

Broadening Continues as Index Struggles Since our mid-year outlook published in May, we have been advocating for a re-emergence of the broadening trade driven by continued strong earnings and our expectation for oil prices to fall and lead to a subsequent cooling off in fears about Fed hikes. Since then, oil prices are down significantly from April highs despite recent volatility. Meanwhile, the average stock is outperforming again along with our preferred cyclical industries for the broadening trade—Consumer Discretionary Goods and Transports. Below is the full list of the key drivers of our broadening call over the past 2 months:

1. The most significant acceleration in earnings growth we have seen for the median stock (mid-teens growth) since the post-Covid recovery, driven by the return of positive operating leverage. 2. The underperformance of Semiconductors as earnings revisions breadth for the group reached upside extremes. 3. Despite a recent bounce, we see oil prices lower over the next several months. We first discussed our views on this front in April as the commodity was peaking. 4. An underappreciated AI adoption tailwind that is gaining momentum. 25% of S&P 500 companies are seeing quantifiable benefits from AI adoption, up from 14% a year…