New York Stock Exchange. Picture: ISTOCK
New York Stock Exchange. Picture: ISTOCK

Investors need to prepare for downside as the end of the economic cycle is near and US 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 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 on Tuesday.

They also said US stock valuations peaked before the tax bill was enacted with a cyclical top for equities later this year, while peak margins and rate of change on organic earnings growth coming by late 2018 or early 2019.

Markets are "closer to the end of the day than the beginning," the authors said in the report.

The report said the fiscal expansion factor supported a range-bound path for stocks, as well as a flatter US 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 [US Federal Reserve] hikes, and yield downside as the year progresses and the economic outlook becomes more mixed."