S&P 500 2021 setup is back, Morgan Stanley says

Morgan Stanley says the S&P 500 2021 setup is flashing again: investors are moving toward steadier, higher-quality megacap shares after an earlier rebound, according to a Monday note from strategists led by Michael Wilson.

The bank’s point is blunt. Market leadership has been shifting toward companies with stronger balance sheets, better margins and less erratic earnings, much as it did in the early-to-middle stretch of 2021 after the post-Covid bounce, MarketWatch reported.

This time, Morgan Stanley says artificial intelligence is the big twist. The bank said profit-margin gains now look more tied to whether companies can adopt AI tools, especially where AI is central to the business and where firms have neutral to strong pricing power.

Why does Morgan Stanley say the S&P 500 looks like 2021?

In Morgan Stanley’s view, the resemblance comes from investor behavior. The bank said weaker balance sheets, more volatile growth stocks and lower-quality earnings factors have started to lag even as the S&P 500 has continued to climb and growth has improved.

A “quality rotation” means investors are favoring companies with sturdier finances and more dependable profits. Morgan Stanley said its factor work currently favors high free-cash-flow yield, less variation in earnings per share, strong balance sheets and high margins.

High-quality megacap stocks now account for about 42% of the S&P 500, according to Morgan Stanley. The bank said low-quality stocks, which can carry heavier debt loads and more volatile earnings, make up just under one-third of the index.

Morgan Stanley named Apple, Micron Technology and Coca-Cola as examples of high-quality companies that rank ahead of many peers in their sectors. The note described those stocks as having earnings growth supported by firm fundamentals and expected future profitability.

How does AI change the stock-market setup?

AI is the new divider in Morgan Stanley’s 2026 comparison. The bank said earnings forecast upgrades are standing out most among companies with enough pricing power and a business model where AI plays a meaningful role.

That matters because higher margins may increasingly depend on using AI tools rather than on the broader rebound forces that helped lift stocks earlier in the cycle. Morgan Stanley’s argument is that quality stocks could keep supporting the index while also helping more companies join the advance.

The bank still flagged risks. Morgan Stanley said the S&P 500 could fall toward 7,000 if the war in Iran escalates or if the Federal Reserve raises interest rates at its Tuesday-Wednesday meeting.

Inflation is another echo from 2021, according to the strategists. They said headline inflation is rising again and is nearly where it stood five years ago, when the price shock was often described as transitional.

Morgan Stanley said today’s inflation increase could also be viewed as temporary because of higher energy prices. For now, the bank’s message is that investors are getting defensive in a familiar way, while AI decides which “quality” companies get the bigger earnings upgrades.

This story draws on original reporting from MarketWatch.