Morgan Stanley predicts that the S&P 500 will reach 7,200 in the next year, marking a 12% increase from current levels. This positive outlook is due to a rebound in corporate earnings, signaling the end of the earnings recession that began in 2022. Several factors are driving this earnings recovery: – Positive operating leverage – Increased AI adoption – A weaker U.S. dollar – Tax savings from OBBBA legislation Additionally, favorable year-on-year comparisons, rising demand across various industries, and potential Federal Reserve interest rate cuts by early 2026 contribute to this optimism.

End of the Earnings Recession

April’s market decline, influenced by tariff news, may signify the end of the earnings recession. The U.S. economy appears to be moving towards recovery, although the market hasn’t fully acknowledged it yet. Morgan Stanley notes that upward revisions in earnings indicate stronger fundamentals. While some worry about high valuations, they believe these are justifiable given the improving economic climate. Market confidence is also boosted by declining economic uncertainty. A new trade agreement with the EU and expected Fed policy easing later this year are enhancing optimism about market growth. This favorable outlook is gaining traction as earnings momentum increases.

Potential Strategies for Investors

With this positive outlook, we believe derivative traders should prepare for a sustained rise in U.S. equities. A simple strategy is to buy call options on major indices like the S&P 500, with expiration dates several months in the future to capitalize on the expected increase. This method lets investors join the rally while keeping risks defined and limited. The earnings recovery described by Mr. Wilson is reflected in the data, making this a credible basis for trading. FactSet reports that the blended year-over-year earnings growth rate for the S&P 500 in Q2 2024 stands at 9.8%, with analysts predicting double-digit growth for the remainder of the year. This data supports the notion that market fundamentals are strengthening. Current market conditions are favorable for adopting these bullish positions. The Cboe Volatility Index (VIX) has been around the 13-14 range, which is historically low. This results in relatively low premiums for call options, creating an opportunity to gain exposure before potential increases in volatility make options more expensive. For those confident that a major downturn is unlikely, selling out-of-the-money put options or put spreads is also an appealing strategy. This approach allows investors to earn premiums based on the belief that the market will either remain steady or rise. Even though the S&P 500’s forward P/E ratio is elevated at nearly 21, above its 10-year average of 17.8, the strong earnings momentum justifies this valuation. The benefits of a weaker U.S. dollar are also becoming evident, as the DXY index has recently declined from its yearly highs. This trend boosts the profitability of U.S. multinational companies, a significant portion of the index. Historically, periods with rising earnings and supportive central bank policies have led to market gains over several quarters. To fine-tune our exposure, we might consider bull call spreads. This strategy entails buying one call option and selling another at a higher strike price, which lowers the initial cost of the trade. This prudent approach allows us to express a bullish outlook while limiting both potential profits and the upfront capital at risk. Create your live VT Markets account and start trading now.

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