Despite geopolitical uncertainty, shifting inflation trends and a more challenging domestic backdrop, the investment outlook remains constructive. The key theme for the second half of 2026 is clear: the global capex cycle continues to support markets, particularly international equities and AI-linked infrastructure.
At the halfway point of 2026, investors are facing a market environment shaped by both opportunity and uncertainty. Geopolitical tensions, oil price volatility, US tariff developments and upcoming mid-term elections are all contributing to short-term market noise. However, Morgan Stanley Wealth Management Australia’s latest Asset Allocation Insights suggests these risks are more likely to affect short-term risk-adjusted returns than derail the broader 12-month total return outlook.
The core view remains constructive. Strong second-quarter earnings, cooling US inflation and signs of a broadening equity rally continue to underpin the bull case heading into the second half of 2026. While global markets are not without risks, the combination of resilient earnings, artificial intelligence investment and a broader capital expenditure cycle supports a preference for equities over credit.
Geopolitical risks remain, but the bull case is intact
Recent geopolitical tensions have contributed to sharp movements in oil prices, with Brent briefly rising above US$100 per barrel amid concerns around the Strait of Hormuz. Morgan Stanley views this move as likely temporary and expects oil prices to drift lower over coming months, which remains important for the broader market outlook.
Oil, tariffs and elections are the three key wildcards for investors. US section 301 forced-labour tariffs took effect on 24 July, with additional tariffs imposed on most economies, while mid-term election uncertainty is expected to keep policy and geopolitical risks in focus. Even so, Morgan Stanley’s base case is that these are risk-adjusted return issues rather than total return problems.
In practical terms, this means bouts of volatility are likely, but they do not necessarily signal a fundamental shift in the investment outlook. Morgan Stanley's preferred positioning remains focused on global shares, especially in the US, while taking a more measured approach to bonds and maintaining neutral exposure to commodities and cash.
AI Build-Out: A US$1.4 Trillion Opportunity
The global AI infrastructure build-out continues to accelerate, with annual investment expected to reach approximately US$1.4 trillion by 2028 and computing capacity forecast to quadruple compared with 2025 levels.
This spending is not confined to technology alone. The AI build-out is broadening into power, cooling, industrial machinery and energy networks, with Asia identified as a key beneficiary. Infrastructure demand remains structurally strong as compute requirements rise and power availability becomes a critical bottleneck.
Morgan Stanley sees the recent AI infrastructure sell-off as technical rather than fundamental. The long-term investment case remains supported by improving model economics, monetisation potential and ongoing demand for the infrastructure required to support AI adoption. However, the outlook also carries risks, including technological disruption, concentrated market leadership, policy divergence and misuse.
Growth is diverging, but capex is the common thread
Global growth trends are diverging, but the capex cycle remains the common thread across major economies. In the US, headline GDP appears softer, yet private domestic demand remains resilient, supported by consumption growth and equipment investment. The July US ISM Manufacturing Index also rose above Morgan Stanley’s forecast and consensus expectations, pointing to further strengthening in manufacturing activity.
In Europe, the July composite PMI increased to 51.9 from 50.0 in June, flagging upside risk to Morgan Stanley’s third-quarter GDP forecast. Japan is also expected to record positive growth, supported by resilient consumption and AI-related export prices that are helping to offset higher import costs.
This backdrop supports the view that the global rally can continue to broaden. Rather than being led only by narrow momentum-driven areas of the market, the next phase is expected to favour quality companies with stable earnings, strong margins and free cash flow.
Inflation is easing, but oil remains the key variable
Disinflation has begun, particularly in the US, where June CPI and PCE data provided a clear signal of easing price pressures. Morgan Stanley expects US core PCE to move from 3.1% in 2026 to 2.4% in 2027, supported by near-complete tariff pass-through, normalising shelter costs and an expected reversal in energy pressures.
However, inflation outcomes are diverging across regions. Europe faces energy-driven headline pressure, while Japan is showing early signs of cost-push inflation. Across developed markets, Morgan Stanley expects headline inflation to peak in 2026 and decelerate sharply in 2027 as energy base effects reverse, though core inflation is expected to remain stickier.
The oil price trajectory is the single most important variable across the US, Europe and Japan. A sustained rise in oil prices would be the key tail risk to the constructive outlook.
Central banks are moving in different directions
Central bank policy is also becoming more divergent. The US Federal Reserve is expected to remain on hold in 2026, with Morgan Stanley forecasting 50 basis points of cuts in 2027. By contrast, the European Central Bank and Bank of Japan are expected to move toward higher rates.
This divergence matters for asset allocation. In fixed income, Morgan Stanley remains underweight overall, but is more constructive on government bonds than credit. Within bonds, Australian government bonds are preferred over international bonds, reflecting higher starting yields and a weaker domestic macro backdrop.
Australia faces a more challenging backdrop
Australia is entering what Morgan Stanley describes as a stagflationary phase, with slowing growth and weaker house prices occurring alongside above-target inflation. The Reserve Bank of Australia is expected to remain on hold with hawkish messaging, with easing unlikely before 2027.
The domestic investment outlook has weakened. Tighter monetary and fiscal policy is expected to slow domestic demand, while earnings risks are rising across banks, consumer discretionary and housing. Australian equities face a mix of sticky costs, weaker volumes, margin pressure, higher discount rates and limited policy relief.
Within Australian equities, Morgan Stanley continues to favour resources and capex-exposed industrials over banks and domestic cyclicals. The broader asset allocation view remains a near-maximum underweight to Australian equities relative to international markets.
Portfolio positioning: stay constructive, but selective
Morgan Stanley recommends an overweight position in equities, reflecting a constructive risk stance and the view that equities continue to offer better risk-reward than credit. Within equities, the US remains the preferred market, supported by positive operating leverage, pro-cyclical policy and AI-driven efficiency gains.
Japan remains the preferred exposure within equal-weight regions, supported by reflation and return-on-equity gains. Europe is held at equal weight amid energy and geopolitical risks, while emerging markets remain the least favoured equity region due to full valuations and fading foreign exchange support.
In fixed income, Morgan Stanley remains underweight overall, with a preference for government bonds over credit. In alternatives, the current environment continues to support an overweight view, with a mix of commodities, including gold, hedge funds and select private investments used to enhance returns, manage volatility and diversify equity risk.
The bottom line
The second half of 2026 is likely to remain noisy, but the underlying investment case remains constructive. Geopolitical tensions, oil volatility and policy uncertainty may continue to create market fluctuations, yet strong earnings, AI investment and a broadening capex cycle remain powerful supports.
For investors, the key is not to de-risk indiscriminately, but to remain selective. Morgan Stanley’s current positioning favours global equities, particularly the US, while maintaining caution toward Australian equities and credit. The capex cycle remains the central theme, and for now, it appears to have further to run.
