Morgan Stanley strategist warns: S&P 500 overvalued by 10%, difficult for Fed rate cuts to solve stock market dilemma
Morgan Stanley's Chief Information Officer and Chief US Stock Strategist, Mike Wilson, has issued a warning that the S&P 500 Index is overvalued by 10%. He believes that the market may remain fragile until it receives positive growth data or more support from the Federal Reserve. The current prices do not yet reflect the support of undervaluation, as the S&P 500 Index is still trading at 20 times forward 12-month earnings forecasts. In addition, the market-leading sectors have shifted to a more defensive posture, indicating a potential early warning signal of a stock market pullback in the rotation of market styles. Valuations this year have reached very high levels, and even an economic soft landing cannot boost the stock market. The market faces a dual challenge of deteriorating economic growth data and the Federal Reserve's reluctance to cut interest rates
According to the financial news app Smart Finance, Morgan Stanley's Chief Information Officer and Chief US Stock Strategist Mike Wilson has shared his views on the market outlook. He believes that the market may continue to be fragile in the short term until it receives more positive growth data or the Federal Reserve provides more policy support, but he predicts that neither of these will happen quickly. Wilson thinks that the market may find some support from undervaluation, but the current prices do not yet reflect this. The S&P 500 index is still trading at 20 times forward 12-month earnings forecasts. Assuming an economic soft landing, a fair value multiple close to 19 times implies that stock prices are not actually cheap until they reach 17-18 times, which is more than 10% higher than the current trading price.
Wilson further analyzes that the process of forming a market top began in April, marking the first major sell-off since last October. Despite many stocks and indices reaching new highs this summer, the market-leading sectors have taken on a more defensive posture, with sectors such as utilities, staples, and real estate outperforming levels seen in the past few years.
The rotation of these market-leading sectors coincides with the weakness in second-quarter economic data. This weakness persisted into the summer, and as Wilson mentioned, key labor market data also joined this trend. The rotation in market styles is an early warning signal that the stock market may be vulnerable to pullbacks, as he emphasized in early July.
Wilson also points out that the third quarter is often a time for seasonal adjustments in the market. Valuations this year have reached very high levels, which is why even assuming economists' basic predictions of an economic soft landing, there is no room for major US stock market gains next year.
The deterioration of economic growth data, coupled with the Fed's reluctance to actively cut interest rates, poses a dual challenge for the market. The Fed tends to focus on the two-year Treasury yield, which has dropped 100 basis points in the past month, nearly 170 basis points lower than the federal funds rate. This suggests that the market is telling the Fed that their policy is too tight and needs a larger rate cut than they have indicated.
Wilson believes that the Fed's dilemma is that the next meeting is six weeks away, which feels like a long time given the current market conditions. The market often lacks patience, so he expects the market to remain highly volatile until the Fed meets market expectations. Of course, on the other hand, if the Fed cuts rates during the meeting, Wilson believes it may exacerbate market concerns about economic growth