This summer has tested the markets’ resilience. While volatility has been a constant companion, equity investors have largely shrugged it off, driving stocks higher and pushing major indexes toward record levels. The S&P 500 has gained 8% year-to-date, supported by strong corporate earnings, steady—if uneven—economic growth, and ongoing enthusiasm for AI-driven innovation.
Yet Morgan Stanley is cautioning clients not to get complacent. Beneath the headline strength, the bank’s wealth management team sees emerging risks that could interrupt the rally and challenge advisors to reassess positioning for the remainder of the year.
Key concerns: A closer look at the indicators that could shift market momentum
A labor market losing steam
Since the July jobs report, there’s been growing skepticism about the true strength of the employment picture. Bureau of Labor Statistics (BLS) data showed the U.S. economy added just 73,000 nonfarm jobs—well below the consensus estimate of 105,000. Adding to the disappointment, job growth for the prior two months was revised significantly lower.
While the Trump administration has publicly questioned the reliability of the figures, Morgan Stanley believes the broader trend points to a genuine cooling in labor demand.
“We believe that the trend, if not the exact level, is substantiated by the broad data mosaic,” said Lisa Shalett, Chief Investment Officer of Morgan Stanley Wealth Management.
She points to the BLS Job Openings and Labor Turnover Survey (JOLTS), which showed openings declining to 7.44 million at the end of June. That translates to an openings-to-job-seeker ratio of roughly 1:1—down sharply from the pandemic-era highs when demand for labor significantly outpaced supply.
Additional economic data supports this slowdown narrative. The Institute for Supply Management’s latest survey indicated employment in the manufacturing sector is contracting at levels historically associated with recessionary periods.
For wealth advisors, this trend matters beyond the headlines. Slower job growth could weigh on consumer spending, pressure corporate revenues, and eventually force the Fed to navigate a more complicated monetary policy path. While wage inflation has eased, a rapid deceleration in hiring could shift sentiment and lead to more defensive positioning across portfolios.
Earnings growth: Strong headlines, narrow leadership
On the surface, Q2 earnings season has been impressive. With several weeks still left in the reporting cycle, more than 80% of S&P 500 companies have beaten consensus estimates. The strongest results have come from technology, communications, and select financial firms, where earnings growth has reached double digits.
But Shalett warns that the leadership is far too concentrated. “Only three of the 11 major equity sectors—information technology, communication services, and financials—posted double-digit gains,” she noted.
The so-called “Magnificent 7”—a small group of mega-cap tech and growth names—are expected to post 26% earnings growth this year. In contrast, the other 493 S&P companies are experiencing flat to modest year-over-year profit changes, barely keeping pace with nominal GDP growth.
This skew raises important portfolio construction questions for advisors. Concentrated market leadership often amplifies volatility risks and increases the vulnerability of benchmarks to sector-specific shocks. While clients have benefited from staying overweight in large-cap tech over the past 18 months, such imbalances may call for greater diversification, active sector rotation, and a readiness to rebalance when leadership broadens—or narrows further.
Inflation and the specter of stagflation
Shalett also points to a shift in macroeconomic risks, with inflation and stagflation concerns moving to the forefront. While current GDP and corporate data suggest the economy remains healthy, the persistence of price pressures—combined with slowing growth—could create a challenging environment for both policymakers and markets.
One factor complicating the outlook is trade policy. The latest round of reciprocal tariffs under President Trump’s ongoing trade disputes has effectively raised average rates to approximately 18%, nearly double the earlier 10% level.
“This may be a case of pain delayed, not denied,” Shalett wrote, cautioning that the inflationary effects of higher tariffs could take months to fully emerge. While near-term economic activity appears resilient, the drag from higher import costs could weigh on both corporate margins and consumer confidence.
For advisors, the possibility of a “stagflationary pause” means preparing for scenarios where equity markets lose upward momentum while inflation keeps real yields under pressure. This environment could benefit certain inflation-hedging assets and require greater emphasis on quality balance sheets, stable cash flows, and pricing power within equity allocations.
Implications for portfolio strategy
For RIAs and wealth managers, Morgan Stanley’s cautionary note is not a call for immediate risk-off positioning, but rather a reminder that the market’s upward momentum is being driven by a narrowing set of conditions that may not persist.
1. Diversification beyond mega-cap growth
The leadership of the Magnificent 7 has been a powerful driver of returns, but the absence of broad-based earnings growth underscores the need for diversification. This could involve allocating more to undervalued cyclical sectors, high-quality mid-caps, or non-U.S. equities that may benefit from different economic cycles.
2. Increased selectivity in fixed income
If labor market weakness deepens and the Fed leans toward rate cuts, high-quality duration exposure could regain appeal. However, inflationary risks from trade policy and supply-side pressures argue for maintaining some exposure to TIPS or floating-rate instruments.
3. Alternative investments for risk-adjusted return
Given the uncertainty in both equity and bond markets, alternatives—including private credit, infrastructure, and certain hedge fund strategies—can help smooth portfolio volatility. The key is ensuring liquidity profiles align with client needs.
4. Tactical readiness for policy shifts
Tariff escalation, labor market deterioration, or a sudden broadening (or further narrowing) of earnings leadership could require swift portfolio adjustments. Advisors should maintain playbooks for these scenarios to ensure clients’ allocations remain aligned with their goals and risk tolerances.
Looking ahead
The late-summer rally may still have legs, but as Morgan Stanley emphasizes, the picture beneath the surface is far more complex than the headline numbers suggest. Labor market momentum is slowing, earnings growth is heavily concentrated, and trade-related inflation pressures could lead to a more difficult macro environment.
For wealth advisors, the message is clear: monitor leading indicators closely, keep portfolio construction disciplined, and prepare for shifts that could come quickly. In an environment where the market’s gains rest on a narrow foundation, vigilance and proactive strategy will be as valuable as asset selection itself.
