It’s a Stock Picker’s Market

Jul 2, 2025

U.S. tax legislation and financial deregulation could help drive wide disparities in stocks’ performance. Here’s how to choose carefully.

Author
Lisa Shalett

Key Takeaways

  • Anticipated corporate tax cuts could boost economic growth and benefit industries like tech, industrials and energy.
  • However, measures to pay for these cuts could drag on consumer spending and sectors like clean energy, while also adding to U.S. deficits.
  • Capital-market deregulation, meanwhile, may enhance bank activities but could intensify competition in credit-linked businesses.
  • Consider stocks with potential for upside surprise in earnings and cash flow while adding diversifying positions in international equities, commodities, energy infrastructure and hedge funds.

U.S. stock market indexes have hit new all-time highs, with the S&P 500 Index up 5% for the year to date. Investors appear to have moved on from worrying about tariffs, geopolitical conflict and economic slowing. They now seem squarely focused on the potential for accelerating corporate profits in 2026 against a backdrop of Federal Reserve rate cuts, corporate tax reductions and capital market deregulation. Investors’ excitement is also building around expectations of a boom in U.S. business productivity and tech innovation in areas like robotics, space and autonomous defense systems.

 

Notably, this equity rally has materialized despite warning signs: stock valuations are extremely rich; CEO confidence remains relatively low, according to recent surveys; and economic data such as retail sales and Institute for Supply Management (ISM) readings have missed analysts’ expectations.

 

Morgan Stanley’s Global Investment Committee can appreciate the powerful appeal of the bull case, which sees the overall market rising higher. However, a deeper analysis of policy implications suggests that under the surface of the market, individual stock returns could be far more wide-ranging than many investors anticipate. This setup favors active stock-picking, rather than passive exposure to a broad market index. Consider the potentially divergent effects from two key policy priorities:

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Wealth Management

Starry, Starry Night

US stocks have climbed to new record highs despite lingering uncertainty. Here’s why now is not the time to be starry-eyed, and why an active investment approach may be key.

  1. 1
    The federal tax-cut bill

    The likely Republican-backed legislation includes business-friendly provisions around the expensing of research and development (R&D), depreciation of capital expenditures and interest-expense deductions. These could help support company earnings, improve cash flow in investment-intensive industries and reduce corporate tax rates, with benefits likely accruing to capital- and R&D-intensive industries such as tech, industrials, energy and health care. All told, Morgan Stanly analysts think the economic stimulus could add about 0.5% to gross domestic product (GDP) in 2026.

     

    However, aggregate gains could be almost fully offset by 2027 when the bill’s so-called “pay-fors” – the measures intended to cover the costs of these cuts – kick in. The variety of proposed cost-saving measures could increase costs for consumers, potentially weighing on spending, while creating challenges for clean energy projects and Medicaid-related health care. Overall, the bill will also likely add to the U.S. government’s outsized debt, with annual deficits projected to continue running at about 6% of GDP through 2035. 

  2. 2
    Capital-markets deregulation

    This shift in policy is also likely to be a double-edged sword. Consider efforts to reduce the capital requirements of global systemically important banks. Lowering the levels of reserves that banks are required to keep on their balance sheets, for example, should free up capacity for activity like bank lending, investment and shareholder buybacks – a positive for mega-cap banks. That said, loosened restrictions are likely to heat up competition in credit-linked businesses, where key segments, especially in private credit, are already facing lower total returns.

     

    Also, recently advanced stablecoin legislation is raising the possibility for entirely new and disruptive business models for cash payments and payroll processing, creating new competition for traditional financial services providers.

Portfolio Moves to Consider

Given current market dynamics, now is not the time to be starry-eyed about the market. There is good money to be made, but investors need to choose carefully.

 

Consider stocks with potential for upside surprise in earnings and cash flow, like select tech companies and others in financials, industrials, energy and parts of health care that are likely to benefit from policy shifts.

 

Also consider diversifying positions in international equities, commodities, energy infrastructure and hedge funds.

 

This article is based on Lisa Shalett’s Global Investment Committee Weekly report from June 30, 2025, “Starry, Starry Night.” Ask your Morgan Stanley Financial Advisor for a copy. Listen to the audiocast based on this report. 

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