Morgan Stanley: Stocks to see slower growth in 2025, though AI adoption could extend rally

The U.S. stock market has delivered exceptional returns exceeding 25% annually for the past two years through 2024, marking one of the strongest bull market periods in recent history. This performance has raised questions about market sustainability as investors enter 2025 with a mix of optimism and caution.

Market Context and Historical Patterns: After two consecutive years of robust gains, historical data suggests that third-year returns in bull markets tend to be positive but more modest.

• The S&P 500’s dramatic rise has pushed valuations to levels that warrant careful analysis
• Traditional bull market psychology has evolved from initial pessimism through skepticism to current optimism
• 2025 may emerge as a “pause year” where corporate earnings growth outpaces stock market returns

AI’s Transformative Impact: The widespread adoption of artificial intelligence technologies across industries is creating parallels to the productivity boom of the late 1990s internet era.

• AI implementation is driving significant operational efficiencies and cost savings across multiple sectors
• Companies successfully integrating AI solutions are seeing meaningful improvements in profit margins
• The technological transformation could extend and strengthen the current market rally

Investment Opportunities: Despite elevated valuations, specific market segments continue to offer attractive potential returns.

• U.S. equities remain favorable compared to international markets
• Both value and growth stocks present compelling opportunities, suggesting a balanced approach
• Sector rotation may become increasingly important as the market cycle matures

Risk Indicators: Several key metrics require monitoring to identify potential market excesses.

• Sustained retail investor buying activity could signal dangerous market euphoria
• Strong positive fund flows might indicate excessive optimism
• Valuations in certain sectors have reached levels that demand careful scrutiny

Portfolio Positioning: An evolving market environment requires strategic adaptation rather than wholesale changes.

• Diversification across both growth and value sectors remains prudent
• U.S. market exposure should maintain a core portfolio position
• Active management may become increasingly important as market returns moderate

Future Trajectory Analysis: While the extraordinary gains of 2023-2024 are unlikely to repeat, several factors support continued market strength.

• Corporate earnings growth appears sustainable, providing fundamental support for stock prices
• AI-driven productivity improvements could extend the market cycle beyond historical norms
• However, investors should temper return expectations and maintain disciplined investment approaches

The durability of this bull market will likely depend on whether AI-driven productivity gains can justify current valuations while avoiding the speculative excesses that typically mark market peaks.