BlockBeats reported on Oct. 5 that Morgan Stanley chief equity strategist Mike Wilson said in his latest report that U.S. stock indexes remain near historical highs, but internal market divergence has become pronounced.
According to the report, 51% of Russell 3000 constituents have fallen more than 20% from their June highs. The median S&P 500 stock is down 16% from its 52-week high, and market breadth has dropped to its lowest level since the dot-com bust.
A 12% gap has opened between index prices and breadth
Wilson said there is now an roughly 12% divergence gap between index prices and market breadth, and how that gap closes will depend on U.S. Treasury volatility.
The report said the 10-year U.S. Treasury yield has climbed to 5.25%, the MOVE Index has moved above 100, while the VIX remains below 15.
Bond volatility may shape the next month for equities
Wilson said that if bond volatility stays elevated, the S&P 500 could retreat about 6% over the next month to around 7,300, then rebound toward year-end. If bond volatility falls first, catch-up gains in individual stocks could allow market breadth to close the gap with the index.
Breadth deterioration began after Jackson Hole in late August
The report said the worsening in market breadth began mainly after the Jackson Hole meeting in late August. Wilson said investors started pricing in a more hawkish Federal Reserve path, rather than reacting to rising oil prices.
He added that the current weakness is showing up mainly through valuation compression, not a slowdown in corporate earnings.
Preference remains with high-quality large caps
On positioning, Wilson recommended staying with high-quality large-cap stocks where earnings revisions continue to improve, especially asset-light companies with high free cash flow yields, low accruals, and high sales per employee.
He also said that if the index completes its pullback, the next month could present an opportunity to add higher-risk stocks.
