Morgan Stanley’s chief investment officer, Mike Wilson, expressed optimism about U.S. equities as the Federal Reserve enters a rate-cutting phase. Despite markets reaching record highs, he believes there is more potential for growth. The Fed’s rate cuts are seen as a supportive factor for equities, with Wilson noting opportunities in small caps amid current market conditions.
Equities and Rate Cuts
Wilson argued against the belief that rate cuts are fully accounted for in the market, stating that equities often perform well during such cycles. Rate-sensitive areas like small caps remain near relative lows. Although acknowledging a traditionally weaker period for stocks in the upcoming weeks, Wilson mentioned that Morgan Stanley plans to buy during market pullbacks. Additionally, he noted that falling policy rates usually support equity valuations, especially when earnings growth exceeds the long-term median.
With the Federal Reserve poised to begin cutting interest rates, we believe U.S. equities have more room to run despite reaching new highs. The CME FedWatch Tool shows a 95% probability of a 25-basis-point cut at the September 20th meeting, fueled by August’s CPI data coming in at 2.8%. This policy shift should serve as a significant tailwind for the market in the coming weeks.
Traders should consider buying call options or selling out-of-the-money put spreads on broad market indexes like the S&P 500. Even though markets are at records, the start of an easing cycle is not yet fully priced into valuations. Historically, equity returns are strong during these periods, as seen in the 2019 cycle when the S&P 500 rallied over 12% in the six months following the first cut.
A particularly compelling opportunity exists in rate-sensitive small caps, which have lagged significantly. While the S&P 500 is up nearly 18% year-to-date in 2025, the Russell 2000 index has only managed a 4% gain. We see this as a catch-up trade, making bullish call spreads on the IWM ETF an attractive way to play the potential rotation with defined risk.
Seasonal Market Weakness
We acknowledge that the coming weeks represent a seasonally weak period for stocks. September is historically the worst-performing month for the S&P 500, with an average decline of around 1% since 1950. This historical trend suggests a potential for short-term pullbacks before the next major leg up.
This seasonal dip should be viewed as a buying opportunity, not a reason to turn bearish. For derivative traders, this means using any market weakness in September to sell puts with October or November expirations. This strategy allows one to collect premium while positioning for the anticipated rally following the Fed’s official move.
