Rising energy prices coupled with bond market volatility: Morgan Stanley's Wilson predicts US stocks may face a 7% correction in the near term.

Morgan Stanley strategists warn that U.S. stocks are facing dual pressures from rising energy prices and bond market volatility, with the S&P 500 at risk of falling as much as 7% in the near term.

In his latest report, Michael Wilson, who led the team, pointed out that the S&P 500 could fall to 7,100 points if financial conditions tighten further or energy prices rise sharply. This level is about 7% lower than the index's closing price last Friday. Nevertheless, Wilson maintains a bullish stance for the end of the year, expecting strong corporate earnings to drive a rebound, with a target of 8,000 points, nearly 5% higher than current levels.

The S&P 500 has been fluctuating since hitting a record high in mid-August, with uncertainty surrounding the inflation outlook weighing on the market. The 10-year Treasury yield is hovering around 5%, and the Federal Reserve also completed its first interest rate hike in three years last week.

Valuation pressures persist, but the foundation for a bull market remains intact.

Wilson stated that while strong corporate earnings have helped stock prices remain resilient in an environment of higher bond yields, the S&P 500's valuation has fallen to its lowest level since March over the past four months.

In his report, he wrote: "If valuation corrections worsen in the near term due to further tightening of financial conditions and/or a sharp rise in energy prices, we believe the S&P 500 could fall to 7100 points before the bull market resumes at the end of the year."

Wilson also expects market volatility to rise ahead of the November midterm elections, but he remains optimistic about the support that corporate earnings prospects will provide for the year-end market.

Energy and the bond market constitute the core risks in the near term.

Energy prices are one of the most important variables in the current market.

While West Texas Intermediate (WTI) crude oil prices have fallen from above $100 per barrel, they are still about 43% higher than their July lows, putting continued pressure on inflation expectations and business costs.

Meanwhile, the Federal Reserve's determination to combat inflation has kept the bond market tense, with the 10-year Treasury yield remaining high near 5%, putting downward pressure on stock valuations. Wilson points out that further tightening of financial conditions is one of the key risk factors triggering a deeper correction.

Profitability support coexists with market divergence

The S&P 500 is currently only about 2% below its all-time high, with the record-strong earnings quarter in the second quarter providing significant support for stock prices.

Regarding market sentiment, both JPMorgan Chase and Goldman Sachs believe that healthy corporate earnings will continue to benefit the stock market. However, according to Bloomberg, Bank of America's (BofA) strategy team warned that investors remain overweight as earnings growth slows.

In his report, Wilson reiterated his recommendation for high-quality large-cap stocks and noted that market momentum is strengthening in service-oriented and asset-light sectors.

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