Morgan Stanley: Tax reduction policies + earnings revisions drive the rise of large-cap U.S. stocks

According to the latest research report released by Morgan Stanley, despite the recent announcement of new tariff policies in the United States, the U.S. stock market has shown strong resilience. In the current environment, thanks to the push from fiscal spending bills and strong earnings prospects, large-cap U.S. stocks are highly attractive.

Resilience of U.S. Stocks Under Tariff Policies

Morgan Stanley strategists, led by Michael J. Wilson, stated that there are three main reasons for the relatively mild response of U.S. stocks to tariff policies: First, considering the range of affected countries and existing exemption policies, the import cost exposure of S&P 500 constituent companies is currently relatively limited. For example, imports from Mexico that comply with the United States-Mexico-Canada Agreement (USMCA) still enjoy exemptions (pending further clarification); Second, market participants generally believe that the recently announced higher tariff rates on multiple trading partners are not the final rates, and negotiations are still ongoing; Third, especially in the consumer goods sector, companies have already experienced significant declines of over 25%.

However, tariff-related risks cannot be ignored. The bank warned that if tariffs against China are significantly increased or USMCA exemptions are canceled, it could pose greater risks to the market. In particular, if the semiconductor industry faces Section 232 tariffs, it could have widespread impacts on the supply chain.

New Tax Legislation Benefits Large-Cap Stocks

Morgan Stanley believes that the newly passed "Big and Beautiful" tax legislation supports large-cap stock indices, mainly reflected in the following aspects: By restoring and expanding expense deductions, the effective cash tax rate for companies may decrease from the current 20% to 13%, thereby improving cash flow; the full deduction of R&D expenses and capital depreciation benefits in the legislation have the most significant impact: the former particularly benefits the technology, communication services, and healthcare sectors; the latter promotes the development of capital-intensive industries (such as aerospace, telecommunications, energy, and industrial/capital goods); in addition, incentives for overseas-derived intangible asset income also benefit large-cap indices due to higher overseas sales exposure; as trade negotiations progress, U.S. companies may also face lower digital services taxes.

Improvement in Corporate Earnings Expectations

The report also pointed out that the significant improvement in corporate earnings revisions (from -25% in mid-April to +3% currently) will become a positive driving force, supporting the market amid ongoing trade and macro uncertainties, especially with outstanding performance in the financial and industrial sectors. Furthermore, as the earnings season approaches, the phenomenon of divergence in earnings revisions is intensifying, which will provide a favorable environment for stock selection.

Looking ahead to the second quarter, the bank's analysts expect the S&P 500 index's earnings per share to grow by 4% year-on-year, with sales growth of 3%. Among them, the net profit growth rate of the "seven giants" is expected to reach 14%, far exceeding the -3% of other companies.

However, there are still some unresolved issues regarding the second-quarter earnings reports, such as the latest impact of tariffs on profit margins, whether there will be more downward revisions in the third and fourth quarters, and whether the progress of tariff negotiations will be sufficient for companies to update or restore guidance