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Market Analysis

Morgan Stanley cautions that if yields remain high, the S&P 500 might reach 4700
Amos Simanungkalit · 1K Views

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April hasn't been favorable for US stocks as higher rates continue to weigh on valuations, and substantial fiscal spending complicates efforts to curb inflation. Consequently, the S&P 500 dropped more than 5% this month, falling below the 5,000 mark for the first time since February.


Morgan Stanley equity strategists attribute the weak performance in equities to the recalibration of expected Federal Reserve rate cuts and the consequent uptick in back-end rates. They highlight the recent tightening of multiples coinciding with a significant rise in the 10-year yield, surpassing the 4.35-4.40% range they've been monitoring since last month.


The strategists anticipate a modest additional downside of around 5% in equity multiples over the next three months if yields persist at current levels, assuming other factors remain constant. This could lead the S&P 500 to retreat to the 4,700 - 4,800 range.


There's concern among Morgan Stanley's clients about the potential for a policy error, driven by last year's aggressive fiscal stimulus, which substantially boosted economic growth but also led to a sizable budget deficit. This deficit created a challenging funding environment and contributed to increased term premiums last summer and fall.


The subsequent dovish shift by the Fed, coupled with lower coupon issuance, resulted in a significant decline in rates and a rally in risk assets. However, this surge in asset prices fueled stronger growth and higher-than-expected inflation, complicating the Fed's previous dovish stance.


Now, with the bond market reacting to hotter-than-anticipated data and pricing fewer rate cuts, the Fed finds itself in a more hawkish position, posing a headwind for valuations. The potential decline in S&P 500 multiples underscores the importance of earnings growth over multiple expansion for stock appreciation moving forward.


Despite Congress likely approving a $95 billion foreign aid bill, the ongoing lack of fiscal discipline counteracts the Fed's efforts to control inflation, contributing to an increased hawkish bias. With 10-year yields surpassing key levels, further stock appreciation will likely hinge more on earnings growth than multiple expansion.

 

 

 


Paraphrasing text from "Investing" all rights reserved by the original author.

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