According to Zhitong Finance, as the selloff in global bond markets continues to intensify, the AI-driven rally in U.S. equities is facing a severe test. Mike Wilson, Chief U.S. Equity Strategist at Morgan Stanley, warned that if bond market volatility increases and long-term interest rates continue to rise, the stock market could experience its first significant correction since bottoming out at the end of March this year.
Bond Market Turmoil Triggers Chain Reaction, U.S. Stocks Face Correction Risks
In their latest report, Wilson’s team pointed out: ‘If the bond market becomes more volatile and long-term interest rates continue to climb, we expect the stock market to experience its first significant adjustment since the low point at the end of March.’
Late last week, the S&P 500 Index had already retreated from its all-time high, and movements in stock index futures also suggested that U.S. stocks would extend their decline on Monday. The core reason for the pressure on market sentiment lies in persistently high energy prices driven by the situation in Iran, with renewed inflation concerns triggering a sell-off across U.S. Treasuries.
As of last Friday, the yield on the 30-year U.S. Treasury bond had climbed to its highest level in nearly three years, while the 10-year Treasury yield also moved back above the key psychological threshold. Meanwhile, Japanese government bond yields surged to multi-decade highs, significantly increasing the risk of global bond market interconnectivity.
Interest Rates to Retreat Only After Geopolitical Clarity; Long-Term Outlook Remains Bullish
Wilson’s analysis suggests that the jump in Treasury yields, combined with the more hawkish signals recently released by the Federal Reserve, reflects two macro realities: firstly, oil prices have continued to rise due to the conflict in Iran, and secondly, the fundamentals of the U.S. economy remain robust.
He added that what the bond market needs for a true retreat in interest rates is not a temporary technical fix but a lasting resolution to the Iran conflict. Until then, the high-volatility environment in the bond market may persist, putting downward pressure on equity valuations.
Despite rising short-term risks, Wilson’s team has not changed its long-term bullish stance on U.S. equities. In fact, they recently raised their 12-month target for the S&P 500 Index to 8,300 points, citing the strongest earnings growth seen by U.S. companies in over two decades, excluding recoveries after major shocks.
Wilson particularly emphasized that investors generally underestimate the breadth of this round of earnings growth spreading beyond AI-beneficiary stocks. The momentum of profit recovery in traditional sectors such as healthcare, industrials, and finance is accelerating, but market capital remains significantly underexposed to these areas that could potentially benefit from ‘earnings diffusion.’
Wilson concluded: ‘Although the breadth of the earnings recovery is expanding, market participants are generally not prepared for it. The two key variables that need to be closely tracked going forward are whether oil prices and interest rates can significantly retreat from recent highs. Only when both variables cool simultaneously can the earnings diffusion rally be expected to truly accelerate.’