Morgan Stanley sees decent equity returns for 2025, although they may seem paltry when compared with the last two years.
The idea of American exceptionalism in the equities markets, where the U.S. has outperformed the rest of the world for over 15 years, is “likely going to stall under its own weight,” said Lisa Shalett, CIO and head of the global investment office at Morgan Stanley Wealth Management, during an online 2025 outlook presentation earlier this week.
Andrew Slimmon, managing director at Morgan Stanley Investment Management, said he fears that investors who were burned in 2022, pulled money out in 2023 and watched from the sidelines in 2024 are now going to come in and out of the market, creating volatility.
And Vishwanath Tirupattur, Morgan Stanley's chief fixed income strategist and director of quantitative research, said the combination of tariffs and sticky inflation could squash growth in 2026.
“Basically, this is a very normal year for us in terms of the outlook for the S&P 500. We’re not getting too bulled up. We're not bearish. We think this is a 5%, 7%, 10% year, but not more than that,” Shalett said.
And while the firm thinks the S&P 500 will wrap 2025 at 6,500, that may change toward the end of the year or early in 2026, as the effects of tariffs and other governmental policies are felt, she said.
Old Policy Shifts, But In A New Order
Tirupattur said that he believes the U.S. is entering a period where the sequencing of new governmental policies will be very important, and there are already clues as to how policy shifts might unfold.
“If we look back to the first Trump administration, the sequencing was we got the Tax Cuts and Jobs Act first,” he said. “And about two years later, we had tariffs become front and center in the policy. This time around, we think it will be very different.”
Instead, tariffs will lead first, and not all at once but dripped out in sector-specific, country-specific, product-specific areas that will build over time and also be used as a negotiation tactic to get things the Trump administration wants from other countries, he said.
Tirupattur said he thinks the Trump tax cuts that are expiring this year will be extended without any significant tax cuts added.
“So from a deficit extension perspective, we do not foresee new tax cuts adding a huge amount to the deficit, and that actually keeps the need for borrowing by the Treasury more controlled,” he said. “It’s probably going to be less than what some people in the markets fear.”
Put it all together, and Tirupattur said he foresees a slow-moving pickup in inflation, ending the year around 2.5%. But as the buildup of tariffs may continue well into 2026, he sees the combination of the two inhibiting growth.
The Bull Market Turns Three
According to Slimmon, the equities market is following a consistent pattern that’s been seen in the past, and that will provide clues about what's to come.
The bear market of 2022 resulted in skittish investors in 2023 who liquidated equity positions rather than see a buying opportunity, a hallmark of the first year of a bull market, he said. In 2024, outflows decreased, but inflows were slow to pick up, which marks the second year of a bull market. And now the equities market is entering what Slimmon called “the optimism phase.”
“People start to believe in the bull market finally, which is tragic because they've largely missed out on the first two years,” he said.
The third year of a bull market is a lower-return environment, he said. Not terrible, but certainly a pause in returns, he said, adding that this will increase volatility, which eventually will shake investors’ confidence.
Meanwhile, the skill of good stock-picking will rise to the forefront because for the last two years, companies didn’t really earn much more than they said they would. But investor confidence started off so low after 2022 that there was a euphoria around that achievement, he said.
Now it’s the opposite—expectations are too high given projections, he said, so good stock selection means finding companies that have a real opportunity to outperform expectations fundamentally, because there won’t be a lift from the market.
AI: A New Opportunity In Fixed-Income Funding
Tirupattur said that higher interest rates have encouraged a new class of investor—yield-based investors as opposed to spread-based investors.
“By any metric, credit spreads today are tight. So the counter to that is ‘spreads may be tight, but the yield is right,’” he said. “The level of the yield that you could get by not taking a tremendous amount of credit risk is 5% to 6%, yields that are really pretty compelling for most fixed-income investors.”
And since interest rates are higher than they were, about 100 basis points higher compared to when the fed started cutting rates, he said, longer duration Treasury rates should end the year lower, not higher.
Meanwhile, the opportunity for private credit will continue to accelerate, he said.
One of the bright spots of fixed-income investing will be in companies that need to invest heavily in artificial intelligence, whether it’s data centers or power generation, in order to transition innovation into mainstream use, he said. And while the largest of companies might be able to pay for that from retained earnings, the average company will require financing.
“So that's a completely new investable opportunity for the credit markets,” he said.
A Great Divide
“As much as we can celebrate American innovation, as much as we can celebrate many of the technologies that have the potential to be transformative in terms of profits, the reality is that a huge amount of American exceptionalism has occurred on the back of monetary and fiscal stimulus,” Shalett said.
That stimulus meant that the largest corporations and the wealthiest households were essentially immune to the Fed’s interest rate hikes. “This was an extraordinary business cycle where 550 basis points of Fed rate hikes did not slow nominal GDP one iota,” she said.
There were pockets of slowdown, such as in commercial real estate, housing and venture capital, she said, but those are no longer big enough to swamp the wealthiest companies and households.
This led Shalett to question whether the American economy is entering a period where the power of scale means “the big will only get only get bigger at a faster and faster rate.” And yet 60% of new jobs are created by small businesses.
“What if small businesses cannot survive?” she asked.