Morgan Stanley: The U.S. stock buyback wave may be peaking, while European stocks are entering an overweight moment

According to the Zhitong Finance APP, the latest message from the Morgan Stanley strategy team has brought the term "cash" to the forefront. Over the past twelve months, the scale of stock buybacks announced by U.S. companies has approached $960 billion, setting a record and equivalent to 1.5 times the average of $644 billion over the past three years; the actual execution amount has also increased significantly, and if the pace remains unchanged in the second half of the year, the total buyback amount will exceed $1 trillion for the first time.

This impressive situation is not driven by "storytelling," but by solid cash flow: the S&P 500 earnings forecast has been continuously revised upward in the first half of the year, with the expected earnings per share for 2025 raised from $255 to $269, and the free cash flow yield (excluding financials) remains steady at over 3%, providing a "munition depot" for buybacks.

More critically, the Comprehensive Budget Act signed by Trump at the end of last year allows for the full expensing of capital expenditures and R&D expenditures in the same year. The Morgan Stanley U.S. team estimates that this alone can contribute $5 to the free cash flow per share of the S&P 500 each year, effectively adding another layer of "buffer" to buyback plans.

However, behind this feast, Morgan Stanley uses three consecutive charts to remind us: buybacks have always been a "cyclical animal." Historical data shows that the correlation coefficient between buyback amounts and earnings per share is as high as 0.8; once earnings expectations turn, buybacks often decline faster than earnings. Currently, the U.S. CEO confidence index has fallen back to pandemic lows, and the economic indicators from the Business Roundtable have been in the "contraction" zone for two consecutive quarters. If the job market further cools, the first budget that companies will cut is the most flexible buyback budget.

More subtly, capital expenditures are on the rise: the proportion of equipment investment in GDP has increased from 2.2% at the beginning of the year to 2.5%, and the combined capital expenditures and R&D of the seven major U.S. tech companies have soared to $450 billion over the past four quarters, an increase of over $100 billion year-on-year. With cash flow being limited, increasing capital expenditures with one hand while wanting to maintain $1 trillion in buybacks with the other will eventually tip the balance.

Shifting focus to Europe, the story presents a "mirror image": although the buyback yield of the Stoxx 600 has risen to 1.5% this year, it is still far below the 3.2% of U.S. stocks, and the absolute scale has stalled for three consecutive quarters. Earnings are the biggest shortcoming—weighted earnings growth for 2025 is -1%, with the median only slightly below single digits, so companies naturally have no money to return to shareholders on a large scale.

However, Morgan Stanley believes that next year, the fiscal baton will be passed to Europe: the fiscal stimulus being brewed in Germany is expected to push the Eurozone fiscal pulse from -0.3% to +0.8%. Coupled with falling energy prices, the earnings growth of the Stoxx 600 is expected to jump to 12% in 2026, significantly faster than the 11% of U.S. stocks. Once the earnings turning point appears, European companies will have "ample resources": currently, buybacks and dividends only account for 15% of earnings before interest and taxes, far lower than the 40% of the S&P, meaning there is less cash gap and more room to increase dividends and buybacks.

Asset pricing is also shifting towards Europe. The equity yield calculated by combining "buybacks + dividends" shows that the Stoxx 600 still has a positive spread of 2% after deducting German 10-year bonds; the same metric for U.S. stocks has turned negative, meaning the attractiveness of holding stocks relative to bonds has been completely erased. Additionally, with the actual interest rate differential of the dollar turning downward, Morgan Stanley's foreign exchange team expects the euro to rise to 1.22 against the dollar by the end of the year, further enhancing European returns through currency conversion On a tactical level, Morgan Stanley has been warning since March that "European stocks have risen too quickly and need to take a breather." Now, the SX5E has been consolidating around 5400 points for six months, lagging 15% behind the S&P. They believe that the "healthy consolidation" is nearing its end and recommend gradually raising European stocks from "neutral" to "overweight" in the fourth quarter. However, they will not rush into it: they will wait for the German fiscal plan to be implemented and for U.S. employment data to confirm a slowdown before officially turning bullish.

As a transition, they prefer to "reduce Japan and increase Europe"—the Nikkei 225 has returned to its early-year highs relative to European stocks. If the new prime minister elected by the Liberal Democratic Party in September delivers on "large-scale fiscal expansion," the Bank of Japan may also announce a reduction in its 37 trillion yen ETF holdings. At that time, Japanese stocks may see a relative momentum decline, and funds will rotate into the Eurozone, which has cheaper valuations and newly initiated stories.

From an industry perspective, Morgan Stanley has upgraded European chemicals, metals and mining, and defense to "overweight," reasoning that falling natural gas prices and marginal recovery in Chinese demand will drive both volume and price increases. They have downgraded semiconductors and automobiles to "underweight," expressing concerns about the dual pressures of inventory and price wars.

In the U.S., technology and communication services account for 64% of buyback volume, but the free cash flow of the seven tech giants has lagged behind net profits for three consecutive quarters. If AI capital expenditures continue to soar while commercialization lags, their status as major buyback players may be at risk; cash flow in the financial sector is stabilizing, raising doubts about the sustainability of buybacks. In other words, the trillion-dollar buyback feast may not be over, but the main players may shift from "U.S. tech" to "European old economy."

In summary: Morgan Stanley is not bearish on U.S. stocks but is presenting "cash flow" data to investors— in the U.S., it’s a competition between profits and capital expenditures for cash; in Europe, it’s a rebound in profits following fiscal easing that brings buyback support. In the fourth quarter, global funds will rebalance, and whoever first holds sustainable cash flow will be able to take over the buyback baton