Mild recession may fuel market gains

[UNITED STATES] Morgan Stanley’s chief U.S. equity strategist Mike Wilson suggests that a mild recession might not be a disaster for the stock market. In fact, it could set the stage for a bullish surge, especially if it prompts the Federal Reserve to cut interest rates and helps reset corporate earnings expectations. While a recession typically hurts profits and confidence, Wilson argues that today’s conditions point to a softer, more manageable downturn.

The bank’s base case sees the S&P 500 rising about 10% over the next 12 months to hit 6,500. If the economy recovers more swiftly from tariff disruptions, Morgan Stanley’s bull case estimates the S&P 500 could climb 22% to 7,200. Interestingly, even under a mild recession scenario, the bank still expects the index to reach the high 6,000s by mid-2026, thanks to eventual rebounds in corporate earnings and investor sentiment.

The mechanics of this rebound hinge on the Federal Reserve. A recession could push the Fed to deliver significant rate cuts — potentially seven in 2026 — which would stimulate the market. Wilson expects small-cap and lower-quality stocks to benefit the most from a low-rate environment, with cyclical, interest-sensitive sectors leading the recovery. Investors are advised to watch closely as rate-cut clarity is expected to emerge in the second half of 2025.

Implications for Businesses, Consumers, and Policy

For businesses, especially in cyclical sectors, the message is cautiously optimistic. While a mild recession could bring short-term pain, including possible layoffs and earnings pressure, the longer-term outlook suggests a favorable environment as interest rates decline and consumer demand revives. Companies that have struggled with high labor costs and borrowing rates may find significant relief in a post-recession rebound.

Consumers may feel the immediate sting of a downturn, especially if layoffs increase, but the predicted Fed response could stabilize borrowing costs for mortgages, credit cards, and other loans. A series of rate cuts would aim to stimulate economic activity, potentially boosting job prospects and disposable incomes by 2026.

For policymakers, the analysis reinforces the importance of responsive monetary action. Delaying rate cuts too long could worsen economic pain, but timely intervention might cushion the blow and set the stage for a healthier recovery. The balancing act between controlling inflation (especially from tariffs) and supporting growth will remain a central challenge.

What We Think

Morgan Stanley’s outlook offers a provocative counterpoint to the usual fear surrounding recessions. “A mild downturn may be exactly what resets an overheated system,” seems to be the underlying argument. We agree that if the Fed acts decisively, the stock market could find its footing faster than many expect. However, this hinges on the recession staying mild — a deeper contraction could derail even the most optimistic projections.

It’s also worth noting the emphasis on small-cap and lower-quality stocks as post-recession winners. Investors often overlook these areas, but they stand to gain the most from cheap borrowing and rising demand. Still, the risks shouldn’t be ignored: corporate America’s reluctance to cut jobs over the past three years could change, and that social cost will ripple beyond markets.

Ultimately, this is a reminder that not all recessions are created equal. For businesses, investors, and consumers, preparation and agility will matter more than fear. The months ahead — particularly the Fed’s signaling — will be critical in shaping how this potential scenario plays out.