Market breadth in U.S. equities continues to broaden even as indexes struggle

Overview

This report is Morgan Stanley's U.S. equity strategy weekly note, focused on market breadth broadening in U.S. equities, the pullback in semiconductor momentum trades, the relative appeal of Hyperscalers, policy resistance to data centers, and the Q2 earnings season. The report argues that although major indexes may struggle to break out in the short term and could continue consolidating, average stock performance is improving, supported by broadening earnings growth, higher AI adoption, expectations for lower oil prices, and a Federal Reserve on hold.

Core views

The core views are: first, the breadth-broadening trade is playing out, and leadership may expand from concentrated momentum sectors into more industries. Second, semiconductors, especially memory-related stocks, had become overheated in both valuation and earnings revisions, and the pullback is not yet fully over. Third, Hyperscalers remain more attractive than semiconductors on a relative basis, though the risk-reward has declined versus a few weeks ago. Fourth, the market may gradually shift toward higher-quality earnings leadership, with high gross margins, high sales stability, and cash conversion worth watching. Fifth, data center construction faces local resistance as well as pressure from energy, water, and household cost concerns, which may affect the pace of AI capex but are more likely to cause delays and added conditions rather than outright bans.

Analysis framework

The report uses a top-down strategy framework combining factor performance, earnings revision breadth, relative sector performance, price analogs, macro variables, policy surveys, and earnings season previews. Its main conclusions are based on comparisons between equal-weighted and cap-weighted indexes, semiconductor earnings revision breadth, semiconductor versus silver-stock price analogs, capex/sales factor performance, quality factor performance, the relationship between transport-sector earnings revisions and ISM manufacturing, as well as data center moratorium bills and consumer survey data.

Methodology notes

• Equity StrategyMarket Breadth Broadening Framework

  Observe whether equal-weighted indexes, the average stock, cyclical sectors, and the breadth of earnings revisions are outperforming concentrated index leadership.

  The report uses the outperformance of the equal-weighted S&P 500 versus the cap-weighted S&P 500, together with relative strength in Consumer Discretionary and Transports, to show that market leadership is broadening from a small number of large-cap momentum stocks to a wider group of equities.

• Factor AnalysisEarnings Quality and Capex Discipline Factors

  Compare the performance and earnings revisions of factors such as high capex/sales, high gross margin, high sales stability, and cash conversion.

  The report argues that the market is beginning to place greater emphasis on capital spending discipline and earnings quality, and that quality factors such as high gross margins and high sales stability may gradually become sources of leadership in the second half.

• Sector RotationSemiconductor Momentum Washout and Rotation Among AI Beneficiaries

  Use earnings revision breadth, price analogs, and positioning concentration to judge whether semiconductors still retain leadership.

  The report notes that semiconductor earnings revision breadth has retreated from extremely high levels, and price behavior relative to silver stocks still points to short-term downside risk, while capital may continue rotating into other AI beneficiaries and undervalued industries with improving earnings revisions.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• S&P 500

  Core strategy observation target

  Strengths

  The index overall is of relatively high quality, earnings expectations continue to be revised upward, and the year-end 8000 target is still viewed as achievable.

  Weaknesses

  It is in a short-term consolidation phase and could continue falling back toward technical support near 7000 if momentum washout spills over or geopolitical conflict escalates.

  Comparison

  The equal-weighted S&P 500 has recently outperformed the cap-weighted S&P 500, indicating improvement in the average stock.

  Risks

  Momentum-trade deleveraging, liquidity pressure, geopolitical conflict, and changes in interest-rate expectations.

• Semiconductors

  Previously a core beneficiary of the AI capex cycle, but short-term relative preference has been downgraded

  Strengths

  The AI capex cycle is still not over, and a tradable rebound may emerge after a deep pullback.

  Weaknesses

  Earnings revision breadth has retreated from historical highs, positioning is crowded, and prices had become overheated.

  Comparison

  The report prefers Hyperscalers over semiconductors.

  Risks

  There may still be about 15% downside in the short term, and expectations that memory pricing has peaked may pressure earnings revisions.

• Hyperscalers

  AI beneficiaries preferred over semiconductors on a relative basis

  Strengths

  Strong core businesses, high optionality at the AI application layer, and underappreciated room for cost-efficiency improvement.

  Weaknesses

  They have already outperformed semiconductors by nearly 30% over the past three weeks, so risk-reward is not as attractive as it was a few weeks ago.

  Comparison

  Still attractive relative to semiconductors, but crowding and short-term gains need monitoring.

  Risks

  The capex/sales factor may no longer be rewarded, credit spreads may widen, and AI capex growth may slow.

• Consumer Discretionary Goods 与 Transports

  Preferred cyclical industries within the broadening market breadth trade

  Strengths

  Both relative performance and earnings revisions are strong, with transport-sector earnings revision breadth near its strongest level since 2021.

  Weaknesses

  Sensitive to the economic cycle and consumer demand.

  Comparison

  They have clearly outperformed the S&P 500 over the past two months.

  Risks

  If macro growth slows or risk appetite weakens, cyclical sector performance could come under pressure.

• Data Center REITs 与电力基础设施

  Potential relative beneficiaries under data center policy resistance and power bottlenecks

  Strengths

  Utilities, on-site generation, and some REITs may benefit from power shortages, interconnection bottlenecks, and their role as critical infrastructure.

  Weaknesses

  Project approvals, community opposition, and regulatory conditions may lengthen construction cycles.

  Comparison

  The report mentions related names such as EQIX, DLR, SEI, INIO, and BE.

  Risks

  Local moratoriums, environmental disclosure requirements, water constraints, pressure on residential electricity prices, and labor bottlenecks.

Key data

• Relative performance of Consumer Discretionary and TransportsBoth have outperformed the S&P 500 by about 12% over the past two monthsUsed to support the case for broadening market breadth and renewed strength in cyclical sectors.
• AI adoption benefits among S&P 500 companies25% of companies are seeing quantifiable benefits, up from 14% a year agoShows that AI adoption is moving from thematic investing toward broader operating contribution.
• Potential short-term downside in semiconductorsPrice analogs indicate about 15% further downsideThe report believes semiconductors may see a tradable rebound, but it is uncertain whether they can regain leadership in the second half.
• Year-end S&P 500 target8000The report believes the year-end target remains achievable if the consolidation ends.
• Value of disrupted data center projectsAbout $156 billion canceled or delayed in 2025, and about $130 billion affected in Q1 2026Local political resistance could cause 2026 AI capex to come in below the estimated $877 billion.
• Potential data center power shortfallAbout 38GW by 2028This is driving a tilt toward on-site generation, energy storage, and grid-support solutions for data centers.
• Q2 EPS and sales expectationsAbout 20% YoY EPS growth and about 10% YoY sales growthThe report believes a mid-to-high single-digit earnings beat rate is achievable.
• S&P 500 earnings revision breadth+19%Although seasonally pausing into earnings season, it remains at a historically strong level.
• Earnings growth for Mag 7 and S&P 493Mag 7 expected to grow 38% in 2026, S&P 493 expected to grow 16%The report also observes early signs of upward revisions in S&P 493 earnings expectations.

Impact & implications

The investment implication is that U.S. equities can still be held constructively over the medium term, but in the short term investors should reduce reliance on semiconductors as the sole source of leadership and focus on industries where earnings revisions remain strong but are not yet fully priced, as well as on high-quality earnings factors. AI capex is not viewed as having reached the end of its cycle, but political, energy, and water constraints on data center construction could change the beneficiary chain: on-site generation, grid support, liquid cooling, water treatment, and some data center REITs may benefit relatively, while companies with high capex but insufficient return discipline may face valuation pressure.

Risks

• Momentum washout could evolve into broader deleveraging, weakening overall risk appetite.
• Current liquidity is only ample rather than extremely loose, and rising demand for equity and bond financing as well as real-economy capex could amplify liquidity pressure.
• The pullback in semiconductor earnings revision breadth and concentrated positioning could continue to weigh on leadership in the technology sector.
• An escalation of Middle East conflict could keep the S&P 500 consolidating or push it lower.
• Local resistance, moratoriums, and energy and water constraints affecting data centers could cause AI capex to fall short of expectations.
• If the Federal Reserve policy path deviates from the on-hold assumption, market valuations and cyclical sector performance could come under pressure.

What to watch

• Whether the equal-weighted S&P 500 can continue to outperform the cap-weighted S&P 500.
• Whether semiconductor earnings revision breadth continues to decline, and whether prices approach a tradable low.
• Whether Hyperscalers continue to outperform semiconductors, especially whether the capex/sales factor continues to be penalized by the market.
• Whether high gross margin, high sales stability, and cash conversion factors become new sources of leadership.
• Whether transport-sector earnings revision breadth and ISM manufacturing improve in tandem.
• Whether state-level and local data center moratoriums spread to the federal level.
• Whether EPS, sales, margins, and earnings revision breadth during the Q2 earnings season continue to support broadening market breadth.