Investing.com -- Investors remain somewhat cautious on U.S. equities, but constructive price action driven by hope for a China trade deal has prompted an influx of questions about what the market is signaling, according to Morgan Stanley.

In a Monday report, the Wall Street bank addressed eight key questions and outlined its top trade ideas.

1 ) ‘ What trades do we like? :’ Morgan Stanley continues to prefer large caps over small, citing superior pricing power and less sensitivity to rates. Within defensives, it sees better value in large-cap Healthcare over Staples, calling Pharma/Biotech “particularly de-risked.”

Among cyclicals, it favors Industrials over Consumer Discretionary goods, and highlights high-quality stocks with strong balance sheets and earnings stability.

The team also recommends selectively picking high-quality cyclicals that have “already discounted a material slowdown.”

Finally, it prefers U.S. equities over international, saying the S&P 500’s quality growth profile and lower earnings volatility should outperform in a late-cycle environment.

2 ) ’ How should one think about index-level ranges and risk/reward here? :’ The S&P 500 has broken through key resistance levels, with 5650 now cleared. The next test lies at 5750–5800, where the 100-day and 200-day moving averages converge.

"We think it will take further, incremental progress on our aforementioned catalysts in the near-term to drive a rally beyond 5750-5800," Wilson wrote.

3 ) ’ What would it take for equity indices to make all-time highs in the near-term? :’ According to Morgan Stanley, a near-term record high would likely require a China trade deal that boosts business confidence and a Fed pivot toward rate cuts. However, the bank notes that its economists "don’t see the Fed cutting rates this year."

4 ) ’ What are the downside risks? :’ The biggest risks are a deterioration in corporate confidence leading to job cuts and a further rise in back-end rates. The note highlights that “a break above 4.50% [on the 10-year yield] is likely to turn the equity return/bond yield correlation meaningfully negative again, thus pressuring valuations."

5 ) ’ What’s the main message from earnings season? :’ Results have been better than feared in this earnings season, with stable guidance trends and positive demand signals in some sectors. Still, the note cautions that tariff uncertainty and weak soft data could weigh on forward earnings if conditions worsen.

"Overall, we’re seeing the 1Q run-rate being extrapolated looking forward in terms of guidance," Wilson said in the note.

"This very well may turn out to be overly optimistic should tariff uncertainty with China persist and the weaker soft data translate into a deterioration in the hard data, but for now, we would characterize the earnings environment as better than feared thus far," he added.

6 ) ’ Why don’t baseline EPS estimates reflect a more material slowdown? :’ Morgan Stanley expects 6% earnings per share (EPS) growth in 2025 and 9% in 2026. It argues that the projected mid-single-digit decline in forward EPS is in line with historical slowdowns that did not result in recessions.

7 ) ’ What would prompt a shift to small-cap/lower-quality equities? :’ A temporary shift could occur if the Fed resumes cuts after softer macro data, but the more durable case would be a mild recession prompting aggressive easing, similar to the March 2020–21 setup, Wilson notes.

8 ) ’ How will U.S. vs. international equity performance evolve? :’ Lastly, Wilson sees U.S. equities outperforming in a late-cycle phase, helped by weaker dollar trends and stronger quality growth characteristics. It says the time to favor international equities would come “after a recession begins in earnest, not before.”