It's possible that global economic growth will stabilize while inflationary pressure remains absent and the top central banks stay on hold for the next 24 months. But that scenario is being overpriced by the markets, according to Morgan Stanley.
At the same time, investors are too dismissive of possible "tails," in which global growth rebounds more strongly amid China's stimulus, or the first quarter's notable earnings weakness has a bigger market impact, according to strategists led by Andrew Sheets.
"The market is too confident in a central scenario," the strategists wrote in a note Sunday.
"Don't buy into Goldilocks," they said of the name given to the scenario of solid but non-inflationary growth.
Morgan Stanley has been skeptical about the strength of the global economy for some time. Mr. Sheets and others wrote in a note in early February that the dollar had likely peaked and the market was underestimating the potential for the currency to fall based on decelerating U.S. growth. That hasn't proven true so far, with economies other than the U.S. showing weakness and the European Central Bank saying it would add stimulus.
The strategists said in the note that they expect major market reversals including a cyclical peak for the greenback, outperformance of emerging-market assets and value scoring over growth. They also recommend buying fixed-income volatility.
Developed markets have outperformed so far this year, with the MSCI World Index climbing 10% through Monday, compared with a near 8% rise in the MSCI Emerging Markets Index.
This year "will see a turning point in macro," the strategists said. They "see challenges to all parts of the market's narrative here, across growth, inflation and policy expectations."