Wall Street’s biggest bear just gave up on waiting for winter.

After predicting a serious stock market correction for over a year, Morgan Stanley’s chief investment officer and chief U.S. equity strategist Mike Wilson changed his tune in a Sunday note, saying he now expects the S&P 500 to rise 1.5% to 5,400 over the next 12 months.

A 1.5% rise in stocks over a 12-month period may not sound like a bullish take, given the roughly 10% average annual return of the S&P 500 over the past 100 years, but it’s a big change of heart for Wilson. The veteran strategist previously expected the blue-chip index to sink 15% to 4,500 over the next 12 months—and he’s been bearish for some time.

This new shift aligns Wilson’s market outlook with the economic forecasts of Morgan Stanley’s chief U.S. economist Ellen Zentner, who raised her GDP growth projections in February and is expecting fading inflation as well as three interest rate cuts this year, which should relieve some of the current pressure on corporate earnings.

As for Wilson, he earned the nod as Wall Street’s top strategist in 2022 for his prescient prediction that stocks would tumble that year due to a combination of “fire and ice” (also known as rising interest rates and fading economic growth). But his pessimistic disposition has led to some misfired forecasts over the past year and a half.

In January 2023, he warned that bullish investors were falling into a bear market trap by buying stocks, noting that his earnings models showed “erosion” in corporate profit margins. “The final stages of the bear market are always the trickiest, and we have been on high alert for such head fakes,” he wrote at the time. “Suffice it to say, we’re not biting on this recent rally because our work and process are so convincingly bearish on earnings.”

Six months later, despite an ongoing surge in U.S. stocks, Wilson argued that markets were headed for disaster due to the Fed’s economy-slowing rate hikes, fading fiscal support, and a profit slowdown. “Risks for a major correction have rarely been higher,” he told investors.

Even this year, Wilson has remained bearish on U.S. markets. Economic growth would need to surge for stocks to continue their run of good form, the CIO argued in January, saying that “this suggests a trading range until the outcome is more definitive.”

All of that turned out to be, well, a bit off base. Between Jan. 2023 and May 2024, instead of dropping like Wilson predicted, the S&P 500 surged more than 38%, hitting a record high above 5,300.

Now Morgan Stanley’s top investor is walking back some of his bearish market calls, at least partly, and it’s due to economic uncertainty. “In short, macro outcomes have become increasingly hard to predict as data have become more volatile,” Wilson wrote in his Sunday note to clients. “We see this environment persisting.”

There’s been a fierce debate over the outlook for the U.S. economy ever since the Federal Reserve began raising interest rates to fight inflation in March 2022. For a time, most economists and Wall Street strategists believed rising borrowing costs and stubborn inflation would ultimately slow the economy to a standstill, leading to a “hard landing” (a.k.a. a recession). But throughout 2023, with the economy proving its resilience to higher interest rates and rising prices, an increasing number of experts became convinced that a “soft landing”—where inflation fades without a job-killing recession—was the more likely path for the U.S. Strong consumer spending, labor market, and corporate earnings data even convinced many forecasters earlier this year that a “no landing” scenario that features higher economic growth and more stubborn inflation is now likely.

Wilson described how the consensus outlook for the U.S. economy has “bounced” between these three scenarios over the past few years due to volatile data releases in his Sunday note to clients, with the last few months of “bumpy” inflation data serving as a “microcosm” of this dynamic.

As a result of this macroeconomic uncertainty, the veteran CIO released a wide range of potential outcomes for U.S. markets over the weekend, including a seriously optimistic bull case and a direly pessimistic bear case.

“We think it makes sense to present a wider range of bull and bear case price targets than usual. Furthermore, we think the probability of the tail outcomes is higher than normal as well, while our base case is less certain,” he wrote.

Wilson’s wider range of potential outcomes for markets is backed up by history. Market returns at the start of interest rate cutting cycles—like the one Morgan Stanley’s economists are predicting will begin later this year—have been all over the place historically. Sometimes markets boom when the Fed begins to cut; other times it’s nothing but bad news.

“In many ways, this analysis encapsulates our outlook well—a balanced risk/reward profile in the average/baseline view, but the potential for a wide array of scenarios to play out,” Wilson wrote. “Once again, get ready for some notable swings in sentiment, positioning and prices.”

While Wilson’s base case outlook for the S&P 500 is now 5,400, if a recession hits, he sees the blue-chip index falling to 4,200, which represents a roughly 20% downside. Corporate earnings and stock market valuations would sink dramatically in this scenario.

However, if the U.S. avoids a recession and the federal government continues to pump money into the economy, driving corporate earnings growth and boosting valuations, then the S&P 500 could surge roughly 20% to 6,350 over the next 12 months, according to Wilson.

“It’s a continuation of the multiple expansion and earnings recovery we have been experiencing,” he explained. “The challenge with this scenario is that inflation may get out of control again and force the Fed to hike, but given its recent predisposition to cut rather than hike even in the face of bumpy inflation data, it appears the Fed may already not be as focused on its 2% target.”

But valuations will ‘normalize’—eventually

Wilson’s base case for U.S. stocks is now far more bullish, and he even argues there could be a “Goldilocks” bull-case scenario for markets if fiscal spending continues and the U.S. avoids a recession. But eventually, valuations will have to come back to Earth. And that means stock market investors should remain cautious and stick with high-quality names, according to the CIO.

“It’s very hard to predict exactly when valuations will normalize, but we remain confident that valuation matters in the end and that we are not in a new paradigm that justifies permanently higher [price-to-earnings ratios],” he wrote.

To Wilson’s point, the S&P 500 currently trades at roughly 25 times earnings, compared to the historical average of just 18 times earnings. Wilson and his team of analysts argued that investors should look to quality stocks—companies with strong balance sheets, cash flows, lower debt levels, and proven business models—in this environment. Because if a recession does hit, the risky, high-flying AI stocks that many investors have fallen for will likely struggle.

Still, Wilson capped off his note with a bit of humility—and a warning that this is an era of uncertainty for markets. “Truth be told, our ability to forecast the [S&P 500’s price-to-earnings ratio] over the last year has been poor and while we are confident valuations are too high, we have little confidence in our ability to predict the exact timing or magnitude of this normalization,” he wrote. “This adds to the higher than normal uncertainty in our outlook for equity prices.”