Morgan Stanley Predicts More Stock Market Damage

Morgan Stanley Says Stock Slide Was Just An Appetizer for the Real Deal.

The U.S. stock market only had a taste of the potential damage from higher bond yields earlier this year.  The biggest test yet to come.

“Appetizer, not the main course.”  This is how the bank’s strategists led by London-based Andrew Sheets described the correction of late January to early February.  Although higher bond yields proved tough for equity investors to digest, the key metric of inflation-adjusted yields didn’t break out of their range for the past five years.

Higher real yields mean a bigger discount rate used to value future earnings.  Interest rates might break out of the range over the past five years as investors anticipate greater central bank policy normalization.  That could hit stocks much harder.

Relatively low real yields were a big support for equity valuations.  As a result, a break higher would indicate that stocks will have to rely on earnings to drive them higher.  Furthermore, the challenge is that a slowdown may loom starting in the second quarter.

“It’s when growth softens while inflation is still rising that returns suffer most.” 

Morgan Stanley’s cautionary message contrasts with other, more bullish sentiments.  BlackRock has expressed optimism that in the near term  corporate profits will be “supercharged” because of the tax cuts.

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