05:17 AM EST, 12/12/2024 (MT Newswires) -- US long-term investors ought to focus on portfolio rebalancing and maximizing their diversification following the recent outsized stock-market gains, Morgan Stanley said in a research note.

Investors should look at stocks, bonds, inflation-adjusted assets, hedge funds, and private investments to diversify their portfolio, Lisa Shalett, Chief Investment Officer of Wealth Management at Morgan Stanley, said in the note Wednesday.

S&P 500 earnings have grown at an annualized rate of almost 8% in Q3. Excluding the so-called "Magnificent 7" mega-cap technology stocks such as Nvidia ( NVDA ) and Microsoft ( MSFT ) , earnings growth is roughly half of that number.

That means corporate profitability has been "lackluster" this year, while the S&P 500 is up almost 28% in 2024, buoyed by lower inflation, interest-rate cuts, and optimism about the new Republican administration.

"Heading into 2025, we caution that once the post-election market enthusiasm ends, investors will need to see stronger corporate fundamentals sustain the narrative of accelerating earnings growth and margin expansion," Shalett said in the note.

The global investment committee at Morgan Stanley favors financials, energy, and residential real estate. They also like manufacturers of industrials and branded consumer goods with a domestic focus.

Shalett pointed out that asset managers have the highest net "long" exposure to the S&P 500 in more than 20 years, signaling an unusually high degree of optimism that the index will keep rising. Enthusiasm among retail investors for stock-market gains in the year ahead has "never been higher" in the 37 years that the Conference Board has been surveying market expectations.

"Finally, we have only seen this kind of outperformance of the momentum factor twice in the last 70 years: during the Tech Wreck of 1999 and the meme-stock crash in 2021," Shalett said. However, she added that the risk to her views are that technical factors such as momentum and liquidity are running strong and could power the S&P 500 another 5% to 10% higher over the next 12 months.