Investors came into July expecting a familiar stock market setup leaning on resilient earnings and AI spending, along with a seasonal stretch favoring equities.
Though Morgan Stanley doesn’t feel that setup has gone away, it warns of a much narrower margin for error.
There’s a major $1.2 trillion question hanging over Big Tech’s AI buildout. If hyperscalers continue bumping capex, the market’s leadership can look a lot more justified. If they slow down, that pressure would spread well beyond chip stocks.
Investors have to contend with this amid a rally that’s still powered by optimism but increasingly vulnerable to one weak signal from earnings, the Fed, or geopolitics.
Morgan Stanley’s $1.2 trillion question for the stock market
Morgan Stanley said AI spending is one of the stock market’s biggest supports, according to a report from Business Insider. The rally continues benefiting as Wall Street repeatedly raises capex estimates for Big Tech, reinforcing the view that the AI trade remains durable.
Moreover, Morgan Stanley’s base case is still aggressive.
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The bank currently expects AI investment to jump from nearly $800 billion in 2026 to roughly $1.2 trillion in 2027, a scale that will continue feeding into demand for chips, data centers, cloud infrastructure, and power.
However, the big risk emerges if Q2 earnings show hesitation.
Morgan Stanley’s Andrew Sheets warned that some major AI spenders have underperformed of late, Business Insider noted. This makes investors a lot less patient with heavy capex and uncertain returns.
Nevertheless, AI spending has powered the market’s earnings story, which is why it’s arguably the biggest factor driving the rally.
FactSet data back up those claims as analysts continue growing more bullish on earnings during the quarter. S&P 500 Q2 2026 profits are now expected to rise 23.3%, up from 18.8% on March 31, spearheaded by the AI-heavy Information Technology sector, which is expected to grow earnings 63.3%, versus 48.6% earlier.
Additionally, tech earnings estimates jumped 9.9% to $223.6 billion, helped by Micron, Nvidia, Apple, and Sandisk.
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Wall Street price targets for S&P 500
According to the Associated Press, the S&P 500 closed at 7,543.64, up 10.2% year to date, while MarketWatch shows a 20.1% gain over the past year at the time of writing.
That said, here are some Wall Street targets from major banks.
- Citigroup: 8,100, citing resilient earnings and an AI-driven growth cycle.
- Goldman Sachs: 8,000, saying earnings growth is powering the market’s return.
- Morgan Stanley: 8,000, with a separate 12-month target of 8,300 tied to earnings strength.
- Wells Fargo: 7,950, pointing to stronger profits and easing macro risks.
- J.P. Morgan: 7,800, citing AI investment, resilient growth and earnings momentum.
Sources: Reuters, AP, MarketWatch, Investing.com, KITCO, Yahoo Finance
Why the summer rally still has room to stumble
Morgan Stanley analysts warn that the market’s margin for error has narrowed, and aside from capex concerns, the market is up against a couple of major headwinds.
The first big risk is oil.
A lot of the stock market’s bull case depends on maritime traffic and normalization through the Strait of Hormuz, oil supply returning to pre-war levels, and Brent crude dropping back toward $75 a barrel over the next 12 months.
However, if we see major escalation with Iran again, those assumptions get a lot tougher to defend.
Naturally, a big spike could bleed into transport, goods prices, and inflation expectations, compelling investors to effectively rethink the soft-landing trade.
The second major risk is the Fed.
Morgan Stanley argues that it is partly built on the belief that policymakers can keep rates steady through year-end. But if inflation pressure builds, the Fed may have less room to wait.
Markets are already alert to that risk, with the CME FedWatch tool showing an 82% chance of at least one hike by year-end.
BofA and Deutsche Bank are perhaps the clearest big-bank hawks, with Reuters reporting that both shifted to Fed rate hikes this year.
I covered the BofA story recently, and the big bank expects three 25-bp increases, while Deutsche Bank expects 50 bps. There’s BNP Paribas, and Macquarie is also in the minority looking for hikes.
Naturally, the rate-cut skepticism has jumped on the back of sticky inflation, the labor market staying resilient, and Reuters saying the Fed’s latest minutes showed policymakers’ inflation concerns had grown substantially.
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