Wilson’s framing makes the Treasury market, rather than earnings, the swing factor for US equities in the near term, which puts oil firmly in the frame: energy-driven inflation from the (ongoing, never ending?) Iran war has been a key driver of the bond volatility he highlights. A calmer bond market would favour a catch-up rally in small caps, cyclicals and the equal-weight index, while persistent yield swings point to a softer S&P 500 as the index falls toward the average stock. His preference for asset-light, quality large caps offers a defensive middle path. The call also complements Citadel’s constructive Q4 view, with both houses seeing much of the damage already done beneath the surface.
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The S&P 500 looks calm, but Morgan Stanley says most stocks have already had their correction, and the bond market will decide whether the index joins them or they catch up.
Summary:
- More than half of Russell 3000 stocks have fallen at least 20% since June, despite S&P 500 resilience, Morgan Stanley says
- The S&P 500 trades on about 19 times earnings, near March lows, with median stock earnings growth in the mid-teens
- If bond volatility persists, Wilson expects the index and broader market to converge in the middle, with a strong year-end finish
- If bond volatility eases, he expects breadth to catch up with the index, lifting both
- The bank favours quality, asset-light large caps with rising estimates and would add riskier stocks on index weakness
- Wilson sees a mid-cycle market and believes consensus underestimates AI-driven margin gains
The S&P 500’s resilience is masking a much weaker US stock market underneath, according to Morgan Stanley, which says more than half of the stocks in the broader Russell 3000 index have fallen by at least 20% since June. This sort of narrative has been doing the rounds for a good while now.
In his latest weekly note, Mike Wilson, the bank’s chief US equity strategist, argued that the gap between the headline index and the average stock shows investors are not complacent about the risks facing equities. The S&P 500 trades on about 19 times earnings, back near its March lows, even as median stock earnings growth is running in the mid-teens, suggesting valuations have already absorbed much of the bad news.
Wilson expects the gap between the index and the broader market to close over roughly the next month, with bond market volatility deciding how. If volatility in bonds persists, he expects the index and the wider market to converge somewhere between their current levels, though still with a strong finish to the year. If bond volatility eases, he expects breadth to catch up with the index, lifting both.
The bank continues to favour large-cap quality stocks, particularly asset-light companies with rising earnings estimates, and would add exposure to riskier stocks if the index falls. Wilson also believes consensus is underestimating the margin gains that AI-focused companies stand to make, and he views the market as being in a mid-cycle phase, with strong earnings growth offsetting lower valuations.
The note continues a theme Morgan Stanley has pressed for much of the year. In March, Wilson warned that the average stock had suffered a stealth correction while the index sat near records, with the gap between the best and worst performing S&P 500 members the widest in two decades. In July, the bank compared the market’s narrow leadership with 2021, when investors crowded into quality megacaps ahead of the 2022 rate-hike sell-off.
More recently, Wilson flagged the risk of a dip of around 7% in the S&P 500 toward 7,100, as rising energy prices and bond market turbulence tightened financial conditions, before a rebound into year-end.
The bond market is now central to that outlook. US 10-year Treasury yields touched their highest level since 2002 this week before easing, as surging oil prices linked to the Iran war and a Federal Reserve on a tightening path pushed borrowing costs higher. Whether that pressure fades will go a long way to determining whether the index falls to meet the broader market, or the broader market recovers to meet the index.
This article was written by Eamonn Sheridan at investinglive.com.