Why U.S. Equities Still Hold Edge Amid Global Uncertainty
16min read Amid a backdrop of tariff wars, Fed uncertainty, and global disinflation, the U.S. equity market’s resilience has confounded skeptics. While the S&P 500’s recent rebound—its longest streak of gains since 2004—has sparked debates over whether the rally is a “false dawn” or a signal of durable strength, Morgan Stanley’s late-cycle analysis reveals a compelling case for U.S. equities to outperform amid chaos. Here’s why investors should lean into quality U.S. assets—and where to avoid pitfalls.
Late-Cycle Dynamics: Resilience Amid the "Pause Year"
The U.S. economy is in its 15th year of expansion, but the current phase—termed a “pause year” by Morgan Stanley—means growth is slowing without collapsing. Key pillars of support include:
1. Labor Market Fortitude: April’s 177,000 non-farm payrolls and 4.2% unemployment rate defy recession fears, underpinning consumer and corporate confidence.
2. Quality Growth Dominance: Large-cap U.S. firms (e.g., healthcare, industrials) are weathering policy storms better than their smaller peers. These companies boast stable cash flows, global scale, and pricing power to offset tariff-driven cost pressures.
3. Structural Advantages Over Internationals: Non-U.S. equities trade at a 40% discount to U.S. peers, yet face their own challenges: Eurozone banks’ fragility, Japanese deflation, and EM fiscal constraints.
Bearish arguments often cite risks like Fed rate hikes and China tariffs. But Morgan Stanley notes that these risks are already priced in. For instance, the 10-year Treasury yield at 4.31% reflects reduced rate-cut expectations, while China’s $40 billion tariff exemption highlights a thaw in trade tensions.
Dollar Depreciation: A Tailwind for Multinationals
The U.S. dollar’s 50% rally since 2011 has reversed, with the euro poised for a 10% rebound as non-U.S. growth stabilizes. This shift is a goldmine for U.S. multinationals, which derive 40–60% of revenue from overseas.
Why this matters:
- A weaker dollar boosts revenue when converted back to U.S. dollars, especially for firms in sectors like industrials (e.g., Caterpillar) and technology (e.g., Microsoft).
- It eases pressure on global consumers, spurring demand for U.S. goods.
While bears warn of Fed hikes reigniting dollar strength, Morgan Stanley argues that global disinflation (core PCE at 3.5%) and policy divergence (e.g., ECB rate cuts) will keep downward pressure on the dollar.
Quality-Driven Sector Rotation: Where to Deploy Capital
The late-cycle playbook favors defensive, cash-rich sectors with pricing power:
- Healthcare:
- Why: Insulated from tariffs and recession, with steady demand for pharmaceuticals and medical devices.
- Play: Overweight S&P 500 Health Care ETF (XLV) or sector leaders like Johnson & Johnson (JNJ).
Industrials:
- Why: Benefit from infrastructure spending and global supply chain normalization.
Play: Focus on firms with global exposure (e.g., Boeing (BA)) or automation leaders (e.g., 3M (MMM)).
Avoid Small Caps:
- Small-cap equities (IWM) face a 25% P/E discount to large caps but lag in earnings growth and liquidity. Their leverage to domestic U.S. policy risks (e.g., tariffs, fiscal austerity) makes them vulnerable.
Risks to Monitor—and How to Hedge Them
While the case for U.S. equities is strong, investors must stay vigilant:
- Fed Policy Missteps: A rate hike in early 2026 (if inflation surges) could push 10-year yields to 6–7%, triggering a rotation out of equities.
Hedge: Use short-dated Treasuries or inverse ETFs (e.g., TBF) if yields spike above 5.5%.
Tariff Escalation: A hardening of U.S.-China trade tensions could disrupt supply chains and hit tech (e.g., Apple (AAPL)).
Hedge: Overweight firms with diversified supply chains (e.g., Procter & Gamble (PG)).
Labor Market Deterioration: A surge in unemployment above 5% would signal a contraction.
- Hedge: Shift into utilities (XLU) or consumer staples (XLP).
Conclusion: The Case for U.S. Equities Is Still Strong—But Act Selectively
The S&P 500’s rebound isn’t a “false dawn.” While risks abound, Morgan Stanley’s analysis underscores that U.S. equities remain the “least dirty shirt” in a global laundry basket of underperformers. Investors should prioritize quality large caps in healthcare and industrials, while hedging against Fed and geopolitical risks.
The late-cycle playbook is clear: Stay long U.S. equities, but stay tactical.
Act now—before the cycle turns.
