The US stock market remains in a state of flux, with the S&P 500 index oscillating within a challenging range. Last week, the index tested both ends of the 5,000 to 5,500 spectrum, ultimately closing slightly above the 5,500 mark on Friday. This movement was largely influenced by optimism around a potential trade agreement with China and anticipated dovish signals from the Federal Reserve.
Michael Wilson, the chief US equity strategist at Morgan Stanley (NYSE:MS), suggests that while the S&P 500 might temporarily surpass the 5,500 level, a sustained advance beyond the impending resistance zone of 5,600-5,650 necessitates several critical developments. These include a significant reduction in tariff rates through a deal with China, a more accommodative stance from the Federal Reserve, long-term yields dropping below 4% without recession indicators, and a noticeable improvement in earnings revisions.
Wilson advises, “Until clearer risk-on shifts in these factors become evident, range-bound trading is likely to persist.” He also highlights the importance of monitoring interest rates, noting that the correlation between equity returns and the 10-year bond yield has diminished recently. This shift indicates that rising yields are more about escalating term premiums rather than robust economic growth.
Wilson commented, “If this correlation continues to weaken and turns negative, the long end of the yield curve will gain significance for equities.” He further added, “A decline below 4% might trigger an upward breakout, whereas a rise above 4.5% could result in risk-averse price actions.”
In terms of investment strategy, Wilson maintains a preference for large-cap, high-quality stocks, particularly within cyclical sectors that have already accounted for a considerable slowdown. He emphasized, “This is not a blanket endorsement for cyclical stocks; rather, it is a selective, stock-specific approach.”
The strategists also observed that while equity markets have primarily factored in a mild economic slowdown, they have yet to incorporate a significant labor market downturn. Until there is “substantial evidence over several months affirming the labor market’s resilience,” the risk of a mild recession remains substantial.
Furthermore, earnings revisions continue to face downward pressure. Wilson pointed out that the breadth of earnings per share (EPS) revisions has dropped to its lowest since 2022, with consensus estimates for 2025/2026 decreasing by 3% thus far this year. Despite these challenges, first quarter EPS surprises have exceeded historical averages, offering some degree of support to the market.
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