Investing.com — Morgan Stanley’s Chief Investment Officer Michael Wilson sees interest rates as the key variable for stock performance in 2025, as rising yields have turned the correlation between bond yields and equities decisively negative.
Wilson highlights that with the now above 4.50%, equity markets are showing renewed sensitivity to rates, narrowing market breadth and weighing on valuations.
“In early December, we highlighted that 4.00%-4.50% on the 10-year yield was likely the sweet spot for equity multiples,” Wilson writes.
A break above this range, driven by either a less dovish monetary policy or a rising term premium, has historically acted as a headwind for stocks. The current climb beyond 4.50% reflects this pattern, contributing to weaker performance across equities.
Morgan Stanley (NYSE:) points to the term premium, rather than economic growth surprises, as the primary driver of higher rates. “Economic surprise indices have fallen and, thus, are not the driver of higher yields,” Wilson notes, reinforcing the view that rates are the most critical factor to monitor moving into the year.
The strategist sees this dynamic as another reason to favor high-quality stocks with stronger balance sheets and less leverage.
“The recent rise in rates provides yet another reason to stay up the quality curve as companies with stronger balance sheets/less leverage are likely to remain less rate sensitive,” the note emphasizes.
Morgan Stanley recommends focusing on industries with strong earnings revisions, particularly Software (ETR:), , and Media & Entertainment.
Reflecting on the close of 2024, Wilson attributes the market’s weak finish to several factors, including a 100 basis point rise in the 10-year yield despite Federal Reserve rate cuts. The bond market’s reaction suggests the Fed may have eased too aggressively, with the term premium climbing by 77 basis points since September.
Looking ahead, Morgan Stanley strategists expect market leadership to broaden in 2025 but “believe it will be concentrated in larger cap, higher quality stocks as we’re entering a late cycle extension as opposed to a new cycle.”
They think that 2025 could be “a year of the halves,” with the first half expected to be more challenging before stock market-friendly policy changes – such as tax cuts or measures to reduce fiscal uncertainty – can make an impact.
Until then, Morgan Stanley advises investors to remain selective and prioritize areas showing strong earnings revisions.
