The US stock market could be in for a rough ride over the next six months as Treasury yields surge and the dollar advances on concerns about inflation. According to Morgan Stanley strategists, this may lead to a challenging period for equities.
Surging Treasury Yields and a Strong Dollar
The correlation between the S&P 500 Index and bond yields has turned decisively negative as the 10-year Treasury yield climbed above 4.5%. Strategist Michael Wilson warned that this trend could put pressure on companies with significant international exposure, ultimately hurting stocks more broadly in the first half of the year.
Market Breadth is Already Poor
The dollar’s advance towards levels that could impact companies with large international exposure may exacerbate market volatility. Given the already poor market breadth, Wilson believes that this could lead to a tough six months for equities.
A Year of Two Halves?
Wilson suggests that 2025 could be a year of two halves, with market-friendly policies such as potential tax cuts likely to support stocks in the latter half of the year. This is in line with the team’s 12-month target of 6,500 points for the S&P 500, implying gains of about 9% from Friday’s close.
The Rally in US Stocks Falters
The rally in US stocks faltered in December on worries about economic growth and a more hawkish-than-expected policy outlook from the Federal Reserve. Technology stocks, which have driven the majority of the gains in the S&P 500 since October 2022, were among the biggest laggards.
Wilson’s Shift to Being More Positive
Michael Wilson was one of the most bearish Wall Street strategists until mid-2024, when he turned more positive on stocks. Despite his expectations for a rally this year, he warns that it is not broad enough yet.
The Divergence in Market Breadth
Wilson notes that the gap between the benchmark index as a whole and its individual components, as measured by the 200-day moving average, is historically wide. This divergence can close in two ways: either breadth improves or the S&P 500 trades closer to its own 200-day moving average.
Closing the Divergence
The first scenario, where breadth improves, likely relies on a combination of lower rates, a weaker dollar, clarity on tariff policy/cabinet confirmations, and stronger earnings revisions. However, Wilson warns that this is not guaranteed and that the market may need to see significant changes before it can recover.
Conclusion
The US stock market faces a challenging six months ahead as Treasury yields surge and the dollar advances on concerns about inflation. Morgan Stanley strategists warn that companies with significant international exposure could be hurt by the strong dollar, leading to broader market weakness. However, Wilson suggests that 2025 could be a year of two halves, with market-friendly policies supporting stocks in the latter half of the year.
Key Statistics:
- The correlation between the S&P 500 Index and bond yields has turned decisively negative.
- The 10-year Treasury yield climbed above 4.5%.
- The dollar is approaching levels that could impact companies with significant international exposure.
- Market breadth is already poor.
- Wilson’s team issued a 12-month target of 6,500 points for the S&P 500, implying gains of about 9% from Friday’s close.
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Sources:
- Bloomberg
- Morgan Stanley strategists
