The S&P 500 might have stumbled coming into November, but Morgan Stanley isn't bothered by short-term noise. The investment bank just lifted its year-end 2026 target for the index to 7,800, which translates to an 18% gain from where we're trading now. Their reasoning? Stronger earnings projections paired with a productivity boost from accelerating AI adoption.
They're not alone in the optimism. UBS recently struck a similar chord, projecting the S&P 500 will hit 7,500 by the end of 2025, fueled by resilient tech profits.
But here's where it gets interesting. According to Reuters, Morgan Stanley sees the market entering what they call a two-speed rally. On one track, you've got the mega-cap tech giants continuing to dominate the AI boom. On the other, small-cap stocks—stuck in neutral for what feels like forever—could finally outperform as the Federal Reserve cuts rates and business confidence comes back to life.
That split creates an unusual opportunity for ETF investors willing to think strategically.
The AI Track: Where Mega-Cap ETFs Shine
Morgan Stanley's thesis hinges on an AI-driven earnings cycle, which puts tech-heavy ETFs right in the sweet spot.
Technology Select Sector SPDR Fund (XLK) offers concentrated exposure to Apple Inc. (AAPL) and Microsoft Corp (MSFT)—the beating heart of the AI productivity trade.
Vanguard Information Technology Index Fund ETF (VGT) goes broader, pulling in chipmakers that are essential to AI infrastructure.
Invesco QQQ Trust (QQQ) remains the cleanest way to play Nasdaq 100 leaders still riding the wave of cloud, data, and automation demand.
These funds stand to benefit most from the surge in capital expenditures Morgan Stanley anticipates. Of course, they're also the most vulnerable if AI valuations get squeezed.
The Small-Cap Track: Positioning For Fed-Cut Liftoff
Morgan Stanley also expects small caps to outperform their larger cousins. A Bank of America survey backs this up: 74% of small and mid-sized U.S. businesses expect higher revenues in 2026, and nearly 60% are planning expansions as supply chains stabilize and inflation cools.
That shifts attention to a few key players:
- iShares Russell 2000 ETF (IWM), the broadest small-cap benchmark out there
- iShares Core S&P Small-Cap ETF (IJR), which focuses on a higher-quality slice of profitable small-cap companies
- ProShares Russell 2000 Dividend Growers ETF (SMDV), a dividend-growth play for investors looking for a defensive angle
These ETFs could finally catch fire after years of underperforming the mega-caps—assuming earnings recover and borrowing costs keep coming down.
Equal-Weight ETFs: Betting On Both Tracks
What if both engines fire at once? If AI giants and cyclical small caps both deliver, equal-weight ETFs give you balanced exposure without having to pick sides.
Historically, Invesco S&P 500 Equal Weight ETF (RSP), ALPS Equal Sector Weight ETF (EQL), and Invesco S&P 100 Equal Weight ETF (EQWL) reduce concentration risk and tend to shine when market breadth improves.
Morgan Stanley's 7,800 call grabs the headlines, but the real story for ETF investors is how this rally unfolds. With tech leadership firmly entrenched and small caps potentially on the verge of a breakout, you might need to pick a lane—or lean on equal-weight strategies to ride both sides of the market at once.