Equity markets could continue to outperform in an environment of persistent inflation and steady economic expansion, while fixed income investors may need to adopt a more selective and diversified strategy, according to the latest report by Morgan Stanley. It further suggests that stronger nominal economic growth, backed by supportive fiscal measures, tax incentives and deregulation, is likely to create a favourable backdrop for equities.
At the same time, the report advises to be cautious when allocating to fixed income, as returns may increasingly depend on active portfolio management rather than broad market exposure.
Morgan Stanley believes inflation is likely to remain above central bank targets even as economic growth stays resilient. The report attributes this outlook to robust labour markets, improving productivity and sustained capital expenditure.
“In this backdrop, equities are likely to benefit from stronger nominal activity, while fixed income may require a more selective and diversified approach to deliver attractive returns,” it noted.
The report also highlighted that corporate earnings expectations have continued to improve, driven by healthy consumer demand, productivity gains and expanding investment activity. Morgan Stanley expects this trend to remain intact as long as businesses continue to increase capital spending.
“We expect this trajectory to persist as long as the CapEx cycle continues to expand,” it said.
Inflation Risks Persist Despite Signs Of Easing Pressures
While inflation remains elevated, Morgan Stanley noted that several factors currently pushing prices higher could gradually lose their impact over time. These include tariff-related costs, elevated energy prices and the effects of artificial intelligence-related investments.
“Inflation may continue to skew high relative to target, while real growth appears poised to remain firm, supported by resilient labour markets, productivity gains and capital investment,” the report noted.
The report further observed that despite relatively high market valuations, equities continue to appear reasonably priced when compared with earnings growth expectations and the strength of the broader economy.
It also expects market participation to broaden if geopolitical tensions ease, with several sectors currently trading at comparatively lower valuations offering scope for recovery.
Emerging Markets Show Mixed Outlook
Morgan Stanley identified divergence as the defining theme for emerging markets. While equity valuations across these markets remain attractive, earnings upgrades continue to be concentrated among economies benefiting from the artificial intelligence boom, particularly Taiwan and South Korea.
However, the report warned that China’s economic outlook remains vulnerable due to weak domestic demand and limited policy support. India, meanwhile, is expected to face a cyclical slowdown as AI- and energy-related challenges weigh on near-term growth.
For fixed income investors, Morgan Stanley recommended a diversified allocation across investment-grade bonds, high-yield debt and emerging market securities rather than relying solely on duration strategies.
“We believe fixed income’s alpha contribution remains dependent on actively managing duration and credit risk,” it said.