Oil Rallies on Fresh Uncertainty

Mike Wilson: Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief U.S. Equity Strategist.

Today on the podcast, I'll be discussing recent concerns around AI disruption.

It's Tuesday, February 24th at 1pm in New York.

So, let's get after it.

Last week you could feel it, that anxious undercurrent in the market. The headlines were noisy, volatility ticked higher, and AI disruption, once again, dominated investor conversations. But beneath the surface level unease something important happened. The S&P 500 Equal Weight Index pushed to a new relative high, keeping our broadening thesis alive and well.

On one hand, investors are worried about AI driven disruption, CapEx intensity, and potential labor force reductions. On the other hand, capital is still flowing into formerly lagging areas of the market, just as the median stock is seeing its strongest earnings growth in four years.

Let's unpack this. First, there's concern AI will lead to job losses. But even if that's the case, there's typically a phase-in period. Companies don't just eliminate labor overnight.  Importantly, before these productivity gains are fully realized, we need broad enterprise adoption. That means building out the agentic application layer, integrating AI into workflows, retraining systems and processes. That takes time, and it is still early days in that regard.

Second, what we're seeing now is typical of a major investment cycle. Volatility increases as markets challenge the pace of unbridled spending. Dispersion increases as investors debate winners and losers. Leadership rotates, sometimes sharply. There's also something different this time compared to the internet bubble of the late 1990s. Today we're in an early cycle earnings backdrop. We've just emerged from what was effectively a rolling recession between 2022 and 2025. So, as capital rotates out of the perceived structural losers, it's not just chasing long-term AI beneficiaries, it's also finding classic cyclical winners.

 On the losing side is long duration services-oriented sectors, particularly software. These areas are more sensitive to uncertainty around longer term cash flows. This area also has a large overhang of private capital deployed over the last 10 to 15 years.

There are other forces at play too. Small cap growth, arguably the longest duration segment of the market, began breaking down in late January around the time Kevin Warsh was nominated as Fed chair. While major indices barely reacted, more speculative areas may be responding to expectations of tighter liquidity given Warsh’s, reputation as a balance sheet hawk. Finally, equity markets are typically more volatile when new Fed chairs assume office.

Bottom line, our broader thesis of an early cycle rolling recovery remains intact. Market internals are supportive even if index level action feels choppy. That said, near term volatility is likely to persist as we enter a weaker seasonal window for retail demand, while liquidity remains ample, but far from abundant.

With this backdrop, a quality cyclical barbell with healthcare makes sense. In small caps, the higher quality S&P 600 looks more attractive than the Russell 2000. And any short-term volatility could present opportunities to add exposure in preferred cyclical areas like Consumer Discretionary Goods, Industrials, and Financials.

 Of course, risks remain. AI adoption could accelerate faster than expected, pressuring labor markets more abruptly. Pricing power could erode as efficiency spread, and policy makers could react in ways that slow the CapEx cycle while crowded momentum positioning remains vulnerable.

Nevertheless, the signal from the internals is clear. Beneath the volatility this looks less like a market rolling over, and more like one that is confirming an early cycle economic expansion.

Thanks for tuning in. I hope you found it informative and useful. Let us know what you think by leaving us a review. And if you find Thoughts on the Market worthwhile, tell a friend or colleague to try it out.

Ariana Salvatore: Welcome to Thoughts on the Market. I'm Ariana Salvatore, Head of Public Policy Research.

Arunima Sinha: And I am Arunima Sinha on the U.S. and Global Economics teams.

Ariana Salvatore: Today we'll be talking about the recent Supreme Court decision on tariffs, what it means for existing trade deals, and where trade policy is headed from here.

It's Monday, February 23rd at 9am in New York.

On Friday, the Supreme Court ruled that the president could not use the International Emergency Economic Powers Act, or IEEPA, to impose broad-based tariffs.

The ruling didn't give a clear signal on what it could mean for potential refunds, but the Trump administration said it plans to replace the existing tariffs, which is something that we'd long expected – first leveraging Section 122 to impose 15 percent tariffs for 150 days.

The president is simultaneously going to launch a few new Section 301 investigations to eventually replace those Section 122 tariffs, since they're only allowed to be in place temporarily. So Arunima, let's start by breaking down some of this tariff math. What does this mean for the headline and effective rate given where we are now versus before?

Arunima Sinha: Before the decision, Ariana, we were at a headline tariff rate of about 13 percent. What this decision does is that with the move, especially to 15 percent, for other countries, we think that it takes about a percentage point off of the headline tariff rate. So, we would go to about 12 percent, and then we have another percentage point coming off just because of the shifts in trade patterns. And so instead of a headline tariff rate of about 13 percent, we think that we're going to be at a headline tariff of just about 11 percent.

But that's really just related to the Section 122s. And as you noted, this is only going to apply for the next 150 days. So how should we be thinking about trade policy going forward?

Ariana Salvatore: I think we should view the 15 percent as probably a likely ceiling for these rates in the medium term; in particular because this 150-day period expires some time around the summer, so even closer to the midterm elections. And as we've been saying politically speaking, it's unpopular to impose high levels of tariffs.

We've also been saying that the president will continue to lean on trade policy as his real, only way to address the affordability issue for voters, which is something that we've actually seen on the policy side for the past few months with the imposition of exemptions, more trade framework agreements, et cetera.

So really, I think this is just another way for him to continue leaning on this policy avenue. But in that vein, let's talk about specific pockets of relief. What are we thinking about some of their findings on a sector level?

Arunima Sinha: So, let's tie this into the affordability aspect that you mentioned, Ariana, and specifically using the consumer goods sector. What we think is that with, just in the near-term period, with the Section 122s applying, for different consumer goods categories, we could see tariff rate differentials go down.

So, they could be anywhere between 1 to 4 percentage points lower across different categories. But what we also think could happen is that once we get beyond the 150-day period, and there are no additional sector tariffs that go on. So, the 232s or the 301s, particularly for this particular sector, we could see some of the largest tariff relief that we're expecting to see.

So, for example, apparel and accessories could see something like a 16 to 17 percentage point tariff drop. So that particular part I think is important. Just the upside risks to consumer goods.

But that of course brings us to the question of bilateral trade deals and how they come into play. What do you think about that, Ariana?

Ariana Salvatore: Yeah. So, I think when it comes to the bilateral deals, as we mentioned, there's some opportunities for relief depending on the sectors and the type of tariff exposure by country. As you mentioned, the consumer goods are a good example of this. So, in general, I think that trading partners will have little incentive to abandon the existing deals or framework agreements, just given that the president and the administration have messaged this idea of continuity. So, replacing the IEEPA tariffs with a more durable, legitimate, legal authority.

But what's notable is that many of our trading partners are actually now facing potentially even lower levels than they were before. Even with the increase to 15 percent on the 122s from 10 percent over the weekend. In particular, many countries in Southeast Asia are actually now facing lower tariff levels since there were somewhere in the range of 20 or maybe even 25 percent before. But as I mentioned, the export composition of these countries matters a lot. So, Vietnam, for example, most exports are subject to the 20 percent tariff because of the IEEPA exposure.

This ruling is more meaningful than somewhere like South Korea, where the exports are more exposed to the Section 232 tariffs. Based on the export composition – and that's a level, remember, that's not changing as a result of this ruling. So that's how we're trying to disaggregate the impact here.

Now, my last question to you, Arunima, what does this all mean for the macro-outlook? As we mentioned, refunds weren't addressed in this ruling. We've sketched out a few different scenarios, most of which leaned toward a long lead time to eventually paying back the money – if and when the administration is actually, in fact, mandated to do that. But safe to say in the near term that we aren't going to see much action on that front. That probably means status quo.

But why don't you put a finer point on what this means for the macroeconomic outlook?

Arunima Sinha: That's absolutely right, Ariana, for the very near term and the second quarter, we don't think we're going to be very different from what our baseline expectation is. In the third quarter and in the last part of this year, there could be some upside risks, especially once the timeline on the 122s run out, they're not extended. And the different sector and country investigations take longer to implement.

So, there could be some upside risks to demand. Consumer goods, for example. If there were to be some sort of an incremental tailwind to corporate margins that might lead to better labor demand from these companies. There could be additional goods disinflation; that would support just purchasing power. So, both of those things could be some incremental uplift to demand, relative to our baseline outlook.

But then the last thing I think just to emphasize from our perspective, is that we do think that there is some sort of a near-term ceiling about how high effective tariff rates can go. We don't think that we're going to be going back to Liberation Day tariff rates in the near-term or even in the latter half of this year. Because if history is any guide, many of these investigations are going to take time and that full implementation may not actually occur before early 2027.

Ariana Salvatore: Makes sense. Arunima, thanks for joining.

Arunima Sinha: Thanks so much for having me.

Ariana Salvatore: And thank you for listening. As a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us wherever you listen, and share Thoughts on the Market with a friend or colleague today.