Michael Wilson: The Market Is Beginning To Question The "Higher For Longer" Narrative

By Michael Wilson, Morgan Stanley chief US Equity strategist

Since mid-July, stocks have experienced a distinct change in personality. As noted in prior research, second quarter earnings season proved to be a "sell the news" event, with day-after-reporting stock performance nearly as poor as we have seen in over a decade. In retrospect, this makes sense given weakening earnings quality and negative year-on-year growth for many industry groups, coupled with the strong price run-up into mid-July on extended valuations. Those valuations look even more extended today, with the equity risk premium falling below 100bp to new cycle lows, as both nominal and real interest rates have risen amid supply/demand imbalances and the Fed’s affirmation that it’s serious about keeping rates "higher for longer."

From an equity standpoint, the real rate/equity return correlation has fallen deeper into negative territory, signaling that interest rates are once again an important determinant of performance. Furthermore, one could argue that the post-Fed meeting response from equity markets was outsized for the rate move we experienced. One potential explanation is that the equity market is beginning to question the "higher for longer" narrative as the macro environment still looks more late cycle than mid- or early cycle.