In a recent interview, John Bilton, Head of Global Multi-Asset Strategy at Morgan Stanley, shared his insights on the current economic landscape and its implications for investment strategies. He highlighted that moderate economic growth, easing inflation, and a shift in the Federal Reserve’s monetary policy are all favorable for risk assets, particularly stocks and credit bonds.

Bilton noted that the Fed’s introduction of a rate-cutting cycle alleviates the risks associated with economic downturns. This development has strengthened Morgan Stanley’s confidence in an extended economic cycle and sustained growth trends. He expressed optimism that as interest rates decline, corporate confidence is expected to improve. While unemployment has risen from its lows, consumer activity remains resilient.

Overall, Morgan Stanley anticipates that U.S. economic growth will slow down to a long-term trend level of 2% over the next two to three quarters, while inflation is expected to return to target ranges by mid-2025. In this environment, Bilton suggested increasing allocations to stocks and credit bonds within multi-asset investment portfolios.

Regarding stocks, Bilton indicated a continued preference for U.S. equities. He projected that as economic growth slows and profit margins reach peak levels, earnings growth for S&P 500 companies is likely to decelerate from 11% this year to 8% by 2025. Nonetheless, corporate balance sheets and cash flows remain robust.

Moreover, despite elevated valuations in U.S. stocks, historical data since 1970 shows that the S&P 500 only experienced negative returns in five out of 41 non-recessionary years, signaling a higher likelihood of stock price increases during periods of economic growth.

Outside the U.S., Morgan Stanley favors emerging market stocks, particularly those excluding Japan and China. The outlook for corporate earnings in Japan appears strong, buoyed by improvements in corporate governance, which suggests further upside potential. Similarly, emerging market stocks, particularly those not in China, present opportunities linked to artificial intelligence (AI) trends and the recovery of the global tech product cycle, benefiting from the Fed’s trend of lowering rates.

On the bond side, Bilton commented that as the economic cycle extends and default rates decline, the spread on U.S. non-investment grade bonds is expected to narrow further. With current yields around 7%, these bonds look attractive, and strong demand in the primary market continues to support performance in this asset class. As no recession indicators are currently visible, the returns on credit bonds are likely to approximate stock returns in the next two to three quarters.

Additionally, Bilton believes that the easing cycle and slowing growth support a favorable view on duration. He pointed out that the declining correlation between stocks and bonds suggests that bonds could regain their role as a hedge in investment portfolios. Consequently, Morgan Stanley has upgraded its stance on duration from a reduction to neutral.