Morgan Stanley: The current correction in U.S. stocks is nearing its end, but Federal Reserve rate hikes remain the biggest risk

Ask AI · Why Morgan Stanley thinks the U.S. stock market pullback is nearing its end?

China Economic Information Services (3月30日) (Edited by Xia Junxiong) Morgan Stanley strategists said in a report on Monday that although the Iran war is still ongoing, the current pullback in the U.S. benchmark equity gauge, the S&P 500, is nearing its final stage. The firm also warned that further Federal Reserve rate hikes still pose a threat to the stock market.

An analyst team led by Michael Wilson, Morgan Stanley’s chief investment officer and U.S. equities strategist, pointed out that an increasing number of signs suggest that this round of market declines is “gradually nearing its end.”

They cited prior examples of several “growth scares.” In those periods, while the market was worried about economic growth prospects, there was no accompanying economic recession or rate-hike cycle.

The strategists noted that in the Russell 3000 index, more than half of the stocks have fallen by over 20% from their 52-week highs. Meanwhile, the S&P 500’s forward price-to-earnings ratio has dropped by more than 15%, indicating that market pricing is increasingly reflecting the risks stemming from the war in the Middle East.

In the report, the strategists wrote: “We believe the stock market’s vigilance about growth risks is higher than the market’s general expectations.”

Since January 27, the S&P 500 has fallen 8.4%. The market has been hit by a dual shock: uncertainty around artificial intelligence (AI) prospects and the impact of the Iran war. The conflict has led to the blockade of the Strait of Hormuz, cutting off an important channel for global energy supply.

As more U.S. troops arrive in the Middle East, and Iran-backed Yemeni Houthi forces join the conflict, Brent crude oil—used as a global oil price benchmark—rose to $116.89 per barrel on Monday.

Morgan Stanley’s team said the market has to a certain extent already priced in higher energy costs. They noted that, compared with historical oil shocks that ended economic cycles, the magnitude of this round’s oil price increase is about only half of what it was in the past. In addition, continued growth in corporate earnings will also help offset recession risks.

Morgan Stanley’s compiled data shows that earnings for companies in the S&P 500 index constituents are expected to grow by 20% over the next 12 months.

“Markets believe that various pathways to restore oil tanker passage through the Strait of Hormuz have a cumulative probability that is significantly higher than the probability that the economy falls into recession, and we agree with this,” the analysts wrote.

However, they also emphasized that rate hikes remain a near-term risk for U.S. stocks. The stock market’s sensitivity to interest rates is currently near the high point from the past few years. The yield on the 10-year U.S. Treasury is also approaching 4.5%, a level that historically typically creates pressure on stock valuations.

The strategists said: “Whether the current rise in U.S. Treasury yields is driven by inflation, a more hawkish Federal Reserve, fiscal deficits caused by the war, or a combination of multiple factors, we believe this is an important risk variable that deserves close attention.”

(China Economic Information Services · Xia Junxiong)