Morgan Stanley Signals S&P 500 Correction Nearing Its End
Growing evidence suggests that the recent S&P 500 correction may be entering its final phase, according to Morgan Stanley’s equity strategy team. However, rising interest rates and ongoing geopolitical tensions continue to cloud the short-term outlook for markets.
Market Shows Less Complacency Toward Growth Risks
Morgan Stanley strategists, led by Michael Wilson, argue that investors are already pricing in growth risks more seriously than commonly believed. This suggests that the market may be more resilient than current sentiment indicates.
More than half of companies in the Russell 3000 index have declined at least 20% from their 52-week highs. At the same time, the S&P 500’s forward price-to-earnings ratio has dropped by 17%, a move consistent with past growth scares that did not lead to recession or aggressive Federal Reserve tightening.
Oil Shock May Already Be Priced In
The team highlighted additional signals indicating that markets have largely absorbed the impact of rising oil prices linked to the Iran conflict.
The relationship between corporate earnings growth and crude oil prices suggests that current oil levels are already reflected in stock valuations. Additionally, defensive sectors such as Consumer Staples have underperformed the broader market since the conflict began, reinforcing the idea that investors are not positioning for a severe economic downturn.
Earnings Growth Remains Strong Compared to Past Cycles
Wilson emphasized that the current environment differs significantly from previous periods when oil price spikes led to economic slowdowns. Earnings per share (EPS) growth is currently running at approximately 14% year-over-year and continues to accelerate.
In contrast, previous cycles that ended in recession saw earnings growth slowing or turning negative. Furthermore, the increase in oil prices today is roughly half the magnitude observed in those historical episodes.
Market Betting on Stability Over Recession
According to Morgan Stanley, market behavior suggests investors believe there is a higher probability of stabilizing global trade flows—particularly in the Strait of Hormuz—than a recession scenario.
This outlook aligns with the firm’s broader view that the correction may be closer to completion than many expect.
Rising Interest Rates Pose the Biggest Risk
Despite improving signals, Morgan Stanley warns that interest rates remain the most significant near-term risk for equities.
The correlation between stocks and bond yields has turned sharply negative, indicating that equities are highly sensitive to rate movements. The 10-year U.S. Treasury yield is approaching 4.50%, a level that has historically led to valuation pressure and market pullbacks.
Fed Outlook Diverges From Market Expectations
Market expectations have shifted toward a more hawkish Federal Reserve stance, with investors now pricing in the possibility of a rate hike this year. This contrasts with Morgan Stanley’s economists, who still anticipate rate cuts.
This divergence adds another layer of uncertainty for investors navigating the current market environment.
AI Sector Positioning Signals Potential Turning Point
Wilson also pointed to developments within the artificial intelligence sector as a potential signal that the correction is maturing.
Memory-related stocks remain heavily owned, while positions in large-scale tech companies are relatively light. Recent developments, including Google’s memory compression updates, could indicate that crowded trades are beginning to unwind—often a necessary step before a market recovery.
Magnificent 7 Stocks Show Relative Value Opportunity
The so-called “Magnificent 7” technology stocks are now trading at valuation levels similar to defensive sectors like Consumer Staples, despite offering significantly higher earnings growth.
From a relative value perspective, Morgan Stanley believes these stocks are becoming increasingly attractive after several months of consolidation.
S&P 500 Target Remains Intact
Morgan Stanley maintains its base-case year-end target of 7,800 for the S&P 500, provided that the U.S. economy avoids entering a recession.
