Markets Risk Short-Term Correction On Overbought Stocks, Morgan Stanley Warns

U.S. equities are overbought after their recent surge in November and risk a short-term correction, Mike Wilson, Morgan Stanley's chief U.S. equity strategist, told Bloomberg.

The Analyst Thesis: The market has become frothy after rallying in the last couple of weeks triggered by positive vaccine news. The S&P 500 and the Dow have gained close to 11% since then.

Vaccine news was a catalyst to get people excited about the market recovery. With the U.S. elections behind, the market is looking forward to the economy’s reopening. There is still a slight risk from the Senate runoff.

What’s happening is a sign of a bull market rally. In such a rally, “bull markets tend to overshoot in the short-term, and any pullback will probably be bought,” Wilson said. The Morgan Stanley analyst is “not incrementally bullish” today as the market has to digest the big move. 

“The market is probably a little bit overvalued quite frankly because interest rates are finally now starting to catch up,” Wilson said. After the jump in treasury yields in the last two days, the interest rates are starting to catch up.

The 10-year yield catch up implies “a valuation reset because stocks are a long duration asset, particularly the U.S. stock market,” Wilson said.

10-year yields nearing 1% leaves investors nervous that a higher discount rate will lower equity valuations. The current equity valuations were last seen at the bursting of the dot-com bubble, reports Bloomberg.

Wilson said any correction would be welcome because it would make him comfortable “putting additional capital to work.”

“Good news for markets can become bad news for equities because bond markets are mispriced,” Wilson concluded.

In the last seven days, Morgan Stanley has maintained an “overweight” rating on Citigroup Inc C and American Express Company AXP, downgraded JPMorgan Chase & Co. JPM and Goldman Sachs Group Inc GS to “underweight,” and upgraded Wells Fargo & Co WFC and State Street Corp STT to “overweight.”