Q: William, how would you describe the state of equity markets today?
A: We are in an environment that looks deceptively calm. But under the surface there are significant cross currents. Global equity indices have become highly concentrated with a small number of mega-cap technology stocks accounting for a disproportionate share of returns. The market is all-in on the AI trade and this concentration and overcrowding create fragility.
Meanwhile valuations are not cheap, with forward multiples on major indices well above historical averages, leaving little room for error if growth disappoints or earnings falter. Investors should not confuse momentum with durability.
And yet, this environment could persist for a while longer which means investors need to tread carefully.
Q: What are the main risks you see as we move through the end of the year?
A: The most immediate risk is likely the equity market taking a cue from the bond market. Some suggest rising sovereign very long bond yields signal higher long-term inflation and or risk premia and this has the potential to infect equity markets, repricing the discount rate investors apply to future earnings. That's when lofty multiples start to look less sustainable. Investors did exactly this at the end of the Dot com bubble.
Another risk is policy uncertainty – for example fluctuating tariff regimes denting business and consumer confidence. Trade tensions and unpredictable regulation are a growing feature of the investment landscape, so far seemingly of little concern to markets. And then there are political and geopolitical risks, such as the Middle East or Russia- Ukraine tensions, all of which could spill over to other markets and jolt sentiment.
Q: How does AI change your outlook?
A: On the one hand GenAI is a genuine revolution, with the potential to boost productivity across industries. On the other hand, the "Magnificent 7" have fuelled an unusually protracted equity market rally where enthusiasm for incremental advances in scaling generative AI technology is reaching a plateau at the same time as harder questions are being asked about the returns that big spending will deliver. What will make the world's tech leaders re-consider the scale of their on-going (and self-funded) arms race on capex in their race for AI supremacy?
We take a measured approach owning selective exposure to AI providers but also identifying durable data-rich compounders that are likely to see further benefits from GenAI.
Q: How does your portfolio look in practice? Where do you see opportunities?
A: We believe the most durable opportunities lie in what we call quality compounders at reasonable valuations. Our flagship fund is built with 30-40 high quality stocks with enduring franchises. We focus on:
- The highest quality consumer staples and health care companies
- Niche software and lower risk AI providers
- A collection of diversified, mission-critical, data rich businesses in financials and industrials.
- Other high quality compounders
This is not about chasing what is fashionable, it's about constructing a resilient portfolio designed to deliver through the cycle.
History shows that quality portfolios compound wealth more consistently, recover faster and avoid the permanent destruction of capital that comes from chasing speculative narratives.
Q: What should investors be thinking about over the next months?
A: Don't be lulled into complacency. Rising long term yields, stretched valuations and negative geopolitical surprises could create bouts of turbulence. Historically, downdrafts from such New Tech-led high market valuations (especially in the US) can be very substantial. At such times, the biggest opportunity can come from being different from the market. What matters is having a portfolio that can withstand those shocks and continue compounding over time. And keep learning - about the future and the past. Technology is advancing faster than ever, but history also offers potential playbooks for how things could unfold.
In a world of uncertainty investors should seek high quality businesses with strong intangible assets, strong free cash flows and management teams that allocate capital efficiently. History shows that it is an effective way for long-term investors to protect against downside while still compounding your investment.
For more information, please browse our Why Quality Matters webpage key fund documents including commentaries and factsheets, as well as portfolio characteristics and insights.
The views and opinions are those of the author as of the date of publication and are subject to change at any time due to market or economic conditions and may not necessarily come to pass. The views expressed do not reflect the opinions of all investment personnel at Morgan Stanley Investment Management (MSIM) and its subsidiaries and affiliates (collectively the Firm"), and may not be reflected in all the strategies and products that the Firm offers.
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