Top-Heavy S&P 500 Looks Primed for Correction to Morgan Stanley

(Bloomberg) -- So few stocks are buttressing the S&P 500’s record-setting rally that the market is vulnerable to shocks, particularly rising rates, according to Mike Wilson, Morgan Stanley’s chief U.S. equity strategist.

As an example of the narrowing market breadth, Wilson pointed to Friday, when Apple Inc.’s 5% gain could be framed as accounting for all of the total return of the S&P 500 and Nasdaq 100. For the week, the S&P 500 climbed 0.7% to an all-time high while the equal-weight version of the index fell 1.5%, a sign that the average stock didn’t participate in the advance like megacaps.

While the lopsided market is nothing new -- the total value of Apple and the other four largest stocks have surged 49% this year while the rest of the market is down 4% -- Wilson says it creates risks for the rally, one that’s been bolstered in part by bond yields hovering near record lows. The recent setback in school reopenings, along with potentially disappointing economic data, could force Congress to introduce a bigger-than-expected stimulus package, which in turn may lead to higher yields in fixed income, Wilson warns.

“We expect a growth scare to be followed by a rate scare over the next weeks/months that could finally give us the first tradable correction in the major U.S. equity indexes,” Wilson wrote in a note to clients. It “could begin imminently,” he said.

U.S. stocks have rallied amid massive fiscal and monetary stimulus, with the S&P 500 jumping more than 50% from the bear-market low in March. Amid the uncertainty over the path of the economic recovery, investors have sought the safety of tech giants, betting on their resilience because of strong balance sheet and an offering of products that cater to social distancing.

While Republicans and Democrats have been in the stalemate over another stimulus bill, Wilson says Congress would be quick to act and come through with a deal in a range of $2 trillion to $2.5 trillion should the economic reopening stall. That may spur a “sharp” increase in long-dated rates given the Federal Reserve’s lack of willingness to employ yield curve control, a move the market is not prepared for, he says.

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