Short-term concerns for stocks might not stem from oil prices but rather from rising interest rates. Increasing bond yields and expectations for tighter monetary policy are putting a strain on stock valuations, already affected by higher energy prices. Michael Wilson, the chief U.S. equity strategist at Morgan Stanley, suggests that the market seems to be factoring in a scenario where limited oil supply doesn’t lead to a recession. He also mentioned that indications show the S&P 500 correction could be nearing its conclusion. Notably, over half of the stocks in the Russell 3000 index have slid more than 20%, entering bear market territory. The S&P 500’s projected price-earnings ratio for the next year has decreased by 17%, reflecting “historic growth concerns without a recession or Fed rate hikes,” according to Wilson’s client note.
Wilson pointed out that there’s a strong inverse relationship between interest rates and stock prices; when yields increase, stock prices typically drop. He identified a significant level at 4.5% for the 10-year U.S. Treasury yield, suggesting that stocks react strongly at this rate. He sees the risk from higher interest rates and a “re-pricing of federal funds futures toward a hawkish stance” as pressing for stocks in the short term. Last Friday, the 10-year Treasury yield rose to 4.48% and finished at 4.44%, while the S&P 500 Index fell by 1.7%. On Monday, the composite index started 0.5% higher as yields decreased. The 10-year Treasury yield fell 9 basis points to 4.35%, but the S&P 500 still dipped 0.4%, largely driven by rising oil prices. Brent crude oil is on track for an astonishing 55% monthly increase.
This drop in yields followed comments from Federal Reserve Chairman Jerome Powell at Harvard University, where he stated that “inflation expectations do appear to be firmly anchored beyond the short term.” His sentiments were echoed earlier by U.S. Federal Reserve Governor Stephen Milan, who noted that the ongoing conflict in Iran is unlikely to impact inflation within the next year. The federal funds futures market had indicated a greater than 50% chance of a rate hike at the end of the previous week, but that probability fell considerably after Powell’s remarks. Morgan Stanley currently views Big Tech as presenting a favorable risk/reward situation, highlighting that the “Magnificent Seven” is trading at a similar multiple (23x) as Staples (22x). Yet, it’s expected to have more than three times the future earnings growth. They anticipate sectors like consumer discretionary, financials, and short-cycle industrials to outperform once the current oil supply issues begin to resolve and tankers are able to navigate the Strait of Hormuz again.
