It’s not just Bank of America that is urging clients to step away from the market’s ultra-narrow semiconductor leadership, and allocate funds to the broader market away from momentum-driven chips and memory stocks. Morgan Stanley’s Michael Wilson has also been vocally pushing a “broadening” trade, and as he writes in his latest Weekly Warm-up note the bank’s broadening thesis continues to gain momentum as Semis underperform. The steep fall in oil has helped to stabilize rates, which is another driver of the rotation to lagging areas of the market. We favor Consumer Discretionary Goods, Transports, and Biotech.”
As Wilson explains, his call for a broadening in market performance is gaining momentum – no pun intended – thanks to several changing factors. As a reminder, the Morgan Stanley strategist first made the broadening call in November 2025 as part of his 2026 outlook. The thesis was based on a core view that the economy had entered a new expansion after completing the rolling recession in April 2025.
Typically, in a new economic expansion, earnings growth turns out to be much better than expected as revenue growth returns to increasingly cost efficient companies: i.e., classic operating leverage. The stock market began to anticipate that trend starting around the same time the call was made in November. However, this broadening was then rudely interrupted by the Iran War in late February. Oil prices surged and market pricing for Fed cuts turned into hikes. As a result, the broadening faded with market performance centered on AI capex beneficiaries, particularly Semiconductors.
Wilson then reiterated his broadening call again with his Mid-Year Outlook in mid May on the view that oil prices had peaked and were likely to fall significantly. Since then, oil prices have peaked, and although the bond market still has 1 ½ hikes priced in for the Fed through 1Q next year, the broadening trade has begun to work again
Wilson also recaps the main pieces of information learned from the June FOMC meeting:
- (1) forward guidance is going to be significantly diminished going forward; and
- (2) the reaction function is now focused more on inflation.
That means much less emphasis on the dot plot and more emphasis on the path of inflation going forward. The Morgan Stanley house view is that the combination of falling energy prices and peaking tariff-related inflation, as well as contained services and housing inflation, keeps the Fed on hold as opposed to hiking rates this year (see “Morgan Stanley Explains Why The Fed Will Not Hike This Year“).
Should this monetary policy forecast play out, it would be a positive surprise for equities via lower policy rate expectations versus what the bond market is currently pricing. Just as the underperformance of Energy stocks was an early signal that crude prices were headed lower, the recent outperformance of several economically sensitive areas and lower rate beneficiaries may be an early indication that policy rate expectations have gotten too hawkish for this year, according to Wilson.
The strategist also found it noteworthy that Chair Warsh commented that “inflation risks have come down” at the Sintra Conference last week. He also offered a bit more emphasis on the employment side of the mandate than he did at the June FOMC meeting, saying that “we have a dual mandate and we have to deliver on both the employment side and the stable price side.” This comment is more interesting in the context of last week’s payroll data, which was notably weaker than expected, which could also help to temper the hawkish rate expectations for now—benefitting the broadening trade.
More relevant to his trade reco is that the Semis trade finally started to lose momentum after a historic run since the end of March. Following the biggest two-day drop in the high-beta momo basket since covid (read memory and chip stocks)…
… this trend is likely to help facilitate broader leadership. This recent underperformance in Semis lines up with both what we have discussed here (see chart below) and Wilson’s own views:
According to toi the strategist, the sharp divergence between the performance of the Hyperscalers and Semiconductors was likely unsustainable given the latter is dependent on the former. In fact, these groups tend to ebb and flow in opposite directions near the end of these divergences, which then leads to the inevitable reconciliation as the Hyperscalers either tone down their capex guidance or indicate they might be going in another direction.
META did this last week by announcing it would begin to sell its excess capacity to outside customers. This comes as the market has gone through periods of questioning the sustainability of the capex growth acceleration. Morgan Stanley recently discussed the peak rate of change in revisions breadth for Semiconductors as the chief reason for why Semis could enter a correction. META provided the rationale for why that might happen now.
While this doesn’t mean the AI capex cycle is over, it can have meaningful resets and rotations along the way. In fact, since ChatGPT was first announced in November 2022, there have been three such corrections in the cycle already. This would be the fourth.
Wilson also highlighted the comparison of Semis with Silver stocks earlier this year. The comparison is twofold: 1) both had parabolic moves higher and 2) both are based on the commodity market, which tends to exhibit wide swings in price over time. The analog we first showed in early June appears to be playing out, and suggests the correction in Semis likely has further to go, led by the Memory subsector—typically the most commodity-like of the Semiconductor complex.
So out of semis and into hypers as part of Wilson’s preferred Broadening theme. What else? As the strategist writes, “we have favored Consumer Discretionary, Regional Banks and Transports as our preferred ways to play the broadening. Obviously, this implies a preference for the equal weighted index relative to the market cap weighted index, not to mention equal weighted versions of each sub-sector that are most geared to the broadening earnings story. Discretionary Goods remains the most compelling expression of this strategy, in our view, given wallet share shift from services to goods, improving pricing in goods and strong EPS revisions.”
In addition to Discretionary Goods and Transports, Morgan Stanley also sees Biotech continuing to outperform. Biotech is one of the most rate sensitive areas of the market, and historically has seen nearly 20% annualized returns in elevated and falling rate regimes.
Given the bank’s view that policy rate expectations remain overly hawkish this year in the context of the house call for core CPI to stay contained below 3%, Biotech offers an attractive risk/reward opportunity. An M&A cycle that continues to ramp up should also benefit the industry. While the group has already started to outperform, rates likely have further to fall in the context of our view on inflation, which should further drive relative strength.
But in light of the massive amounts of capital at risk, Wilson’s most important recommendation is Hyperscalers over Semis for the near term as there is potentially more risk that other Hyperscalers begin to temper expectations on the rate of change on capex growth given the poor performance of their stocks over the past few months as capex expectations continued to ramp, a theme we have hammered for weeks and weeks.
In addition, Wilson continues to see the Hyperscalers as having attractive optionality within the AI ecosystem: strong core businesses, the ability to participate in/lead the agentic application layer development and implementation, as well as an underappreciated cost cutting lever. On that note, the Morgan Stanley high capex/sales factor could be topping for now after a torrid run over the past year.
Hyperscalers have led in terms of discounting this dynamic and have already gone through their period of underperformance.
Still, Wilson is careful not to be misinterpreted as calling the end of the capex cycle or the end of the chips trade, and sees the recent moves as “a near-term peak rate of change in revisions dynamic, not a peak in the broader capex cycle.” Still, the market has seen relative performance oscillate between the various types of AI beneficiaries over the past couple of years and Wilson expects those rotations to continue as the cycle evolves. “This is simply the next rotation, Semis to the Hyperscalers and other broadening trades noted above” Wilson concludes.
For his bottom line, the MS strategist writes that his “view that markets would begin to broaden out as the indices began to consolidate / correct is happening.” The recent underperformance of Semis after Micron reported earnings suggests the peak rate of change in revisions is top of mind for markets in the context of an AI cycle that is far from over. Meanwhile, “leadership has been oscillating for years among AI winners. This is simply the next rotational development in the cycle.” Meta’s unexpected announcement to sell its excess compute to outside customers underscores this dynamic. And now, the high capex / sales factor is starting to consolidate, which may encourage others to temper capex guidance. All of this will encourage the broadening trade, which is clearly in gear.
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