Morgan Stanley says to watch rates as stock correction is almost over
The biggest near-term risk for stocks may be rising interest rates — not oil. Higher bond yields and increased expectations for tighter monetary policy are putting pressure on stock valuations, which have already dropped due to rising energy prices. This could be because markets have priced in a scenario where oil supply is constrained but does not trigger a recession, according to Morgan Stanley chief U.S. equity strategist Michael Wilson. He said there is growing evidence the S & P 500 correction is nearing its ending stages. There has been significant damage “under the surface” in markets with over 50% of the stocks in the Russell 3000 index down more than 20% — bear market territory — while the S & P 500 ‘s forward price-to-earnings multiple for the next 12-months has declined 17%, matching “prior growth scares in the absence of a recession or the Fed hiking,” Wilson said in a note to clients. .SPX 3M mountain S & P 500 performance over the past three months He noted the negative correlation between interest rates and stocks, meaning stocks decline in value when yields rise, is about as high as it’s been in several years. He cited the 4.5% level in the 10-year Treasury yield as the point where it really begins to affect stock valuations. The “re-pricing of fed funds futures toward a more hawkish outcome” along with higher rates is what Wilson sees as the bigger risk for stocks in the near-term. The 10-year yield climbed as high as 4.48% on Friday before closing at 4.44%, while the S & P 500 closed lower by 1.7%. One basis point equals 0.01%, and yields move inversely to prices. On Monday, the broad index opened 0.5% higher as yields fell. The 10-year yield retreated by 9 basis points to 4.35%, but the S & P 500 index eventually succumbed to higher oil prices closing down by 0.4%. Brent crude, the global benchmark, is pacing for a record monthly gain on 55%. The decrease in yields followed comments from Federal Reserve Chair Jerome Powell during a talk at Harvard University where he said that “inflation expectations do appear to be well anchored beyond the short term.” His remarks were echoed earlier in the day by Federal Reserve Governor Stephen Miran, who said in a CNBC interview that he doesn’t see signs the current war in Iran is having an impact on inflation beyond the next year. Fed fund futures had been pricing in a greater than 50% chance of a rate hike at the end of last week, according to data from the CME Group’s FedWatch tool, but these odds have fallen significantly following Powell’s comments. Morgan Stanley sees Big Tech as having a favorable risk/reward profile at the moment, noting that the “Magnificent Seven” “trades at nearly the same multiple (23x) as Staples (22x; a popular defensive hedge) but it has over 3x the forward earnings growth.” If the current oil supply shortage begins to abate and tankers begin to transit the Strait of Hormuz once again, Morgan Stanley expects the consumer discretionary, financials and short-cycle industrials sectors will outperform.
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