Recession Could Be Bullish? Morgan Stanley Sees Silver Lining in a Mild Downturn

As policy uncertainty escalates following the return of President Donald Trump to the White House, a growing number of economists are voicing concerns about rising recession risks in the U.S. economy. But Morgan Stanley offers a contrarian view: a mild economic recession might not be bad news for the stock market—in fact, it could lay the groundwork for a bullish rebound.

This view, admittedly unconventional, challenges mainstream economic logic. After all, recessions are typically associated with shrinking corporate profits, dampened consumer spending, and declining investor confidence.

Yet in Morgan Stanley’s latest report, Chief U.S. Equity Strategist and Chief Investment Officer Mike Wilson argues that a mild recession could ultimately support equity upside—particularly if it triggers a Federal Reserve rate cut and resets overly optimistic earnings expectations.

A Recession, Then a Rally?

Following the Geneva joint statement, tensions between the U.S. and China appear to have eased slightly. Against this backdrop, Morgan Stanley notes that the likelihood of a U.S. recession has diminished somewhat compared to earlier this year.

In its mid-year outlook, the bank forecasts the S&P 500 to reach 6,500 over the next 12 months—implying about 10% upside from current levels. Should the U.S. economy rebound faster than expected from tariff-related shocks, the index could climb to 7,200 by June next year—an impressive 22% rise from current levels.

But Wilson also outlines another, more unexpected bullish case: a mild recession followed by a rebound.

He envisions a scenario in which the U.S. slips into a mild recession in the summer or fall, triggering a selloff akin to the April correction. However, this would be followed by a rebound—perhaps not to new highs, but potentially back to the 6,000 range within 12 months.

"Given the rolling recessions we have already experienced and muted growth in much of the private economy over the past few years, we believe the decline in EPS would be more mild than during past recession," Wilson wrote.

Layoffs Could Trigger Fed Action

According to Wilson, in the coming months, U.S. companies may increasingly respond to tariff-related uncertainty by cutting labor costs—a move they've largely avoided over the past three years. This wave of layoffs could put additional pressure on the Fed to act, especially if inflation tied to tariffs persists while growth weakens.

A Fed focused on inflation risks may hesitate to cut rates, but a rise in unemployment could eventually force its hand.

Morgan Stanley economists now expect the Fed to implement a total of seven rate cuts by the end of 2026, which would act as a major tailwind for equities. Wilson expects the market to bottom out in early 2026, followed by a recovery led by rate-sensitive, cyclical sectors—industries that were hit hardest by rising rates and reduced government spending.

"Specifically, EPS growth should trough in modestly negative territory in early 2026 but would be followed by a significant reacceleration in growth led by the more cyclical interest sensitive sectors that have been hurt the most from the crowding out of government spending and higher rates," Wilson wrote.

Wilson believes a rebound could test stock market highs comparable to the 23x earnings valuations seen in the post-pandemic era.

“If a mild recession does occur,,” Wilson wrote, “investors should expect small caps and lower quality stocks to be the biggest winners, that's because small-cap companies tend to experience relief in low-rate regimes.”

He advises investors to closely watch the second half of 2025, when the Fed's policy trajectory should become much clearer.