Morgan Stanley strategists have cautioned that climbing government bond yields and a strong U.S. dollar could pressure American equities in H1 2025.
Mike Wilson, the bank’s chief U.S. equity strategist, leaned bullish in November 2024 when he predicted an 11% upside for stocks by 2025. However, it appears that Wilson is now concerned about a potential drawdown over the next six months.
As of Monday morning, the 10-year U.S. Treasury note’s annual yield stood at around 4.6%. Meanwhile, the U.S. dollar has been on a hot streak since early October.
These factors could be problematic for U.S. stocks since they are typically measured against the dollar and because high-yielding bonds may entice investors away from stocks.
Amid this backdrop, Wilson noted that the correlation between the S&P 500 (SPX) and Treasury yields has turned “decisively negative”. Furthermore, he claimed that the dollar is approaching levels that could pressure businesses with a large degree of international exposure.
Additionally, Wilson feels that the rally in U.S. equities has poor breadth. Consequently, he expects these factors to hurt stocks during the first half of 2025.
On the other hand, Wilson offered a potentially happy ending to this story, stating, “We think 2025 could be a year of two halves”. He argued that after a possible drawdown in the year’s first half, market-friendly policies such as tax cuts are likely to shore up stocks in 2025’s second half.
Analysis: No need to panic-sell stocks now
Certainly, Wilson isn’t the first commentator to warn about high bond yields, the dollar’s strength, and the stock rally’s lack of breadth. The Morgan Stanley strategist echoed a long-standing concern among market watchers, proclaiming, “Either breadth improves or the S&P 500 trades closer to its own 200-day moving average”.
Even with that cautionary note, however, Wilson still anticipates that the S&P 500 will rally this year. In other words, the Morgan Stanley strategists aren’t turning ultra-bullish at this point.
Moreover, it’s difficult to time near-turn price moves in the financial markets. Hiding in an all-cash position for six months could result in unfortunate opportunity costs for nervous investors.
Hence, there’s no immediate urgency to dump all U.S. stocks based on Wilson’s warning. Instead, investors can acknowledge the Morgan Stanley strategists’ concerns, stay watchful, and be prepared for a wide range of possible outcomes for 2025.
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