Investors need to prepare for downside because the end of the economic cycle is near and U.S. markets are priced for best-case scenarios, Morgan Stanley says.
While fiscal stimulus is supportive of growth in the near term, the benefits are already likely "in the price" and increase the potential downside for markets at the end of the cycle, Morgan Stanley strategists including Michael Zezas, Matthew Hornbach and Andrew Sheets wrote in a note Tuesday.
They also said U.S. stock valuations peaked before the tax bill was enacted, with a cyclical top for equities coming later this year, while peak margins and rate of change on organic earnings growth will be coming by late 2018 or early 2019.
"There's less reason to behave like it's 'morning in America' than 'Happy Hour in America,'" the report said. Markets are "closer to the end of the day than the beginning."
The report said the fiscal expansion factor supports a range-bound path for stocks, as well as a flatter U.S. Treasury yield curve with a lower yield bias.
"We advocate a focus on sector and stock-specific alpha as these late-cycle dynamics portend narrowing markets and a cyclical top for equities later this year, in our view," the strategists said. "In Treasuries, we see the curve continuing to flatten on Fed hikes, and yield downside as the year progresses and the economic outlook becomes more mixed."