Correction Is On the Way! Morgan Stanley Warns of 3 Risks That Could Turn the Market Down

U.S. stock investors welcomed Donald Trump's return to the White House, but the post-election rally is not without risks.

As investors bet on the prospects of Trump's proposed tax cuts and deregulation policies boosting the stock market, the three major U.S. stock indexes have continuously hit record highs since the U.S. election on November 5, until they reversed the upward trend on Tuesday.

Morgan Stanley recently outlined three risks that could disrupt the Trump trade in a report. The bank stated that, first, a significant rise in U.S. Treasury yields could trigger anxiety among stock investors.

Trump's election has already led to a surge in U.S. Treasury yields, as Wall Street expects his policies to drive up inflation and keep interest rates high. On November 6, the yield on the 10-year U.S. Treasury note rose by 21 basis points to 4.47%.

So far, this has not been enough to shake stock investors' confidence, but Morgan Stanley indicated that a further rise in Treasury yields could spell trouble for the stock market. The firm pointed out that concerns about the ever-growing government deficit could push yields higher.

Analysts at JPMorgan also share this view, noting that once bond yields approach 5%, the stock market rally will lose momentum.

Second, a strengthening dollar could pose problems for large-cap stocks.

After the election, the Bloomberg Dollar Index recorded its largest gain in four years, reaching its highest level since November 2023.

Similar to bond yields, the dollar is soaring as the market expects U.S. interest rates to remain high for a longer period under Trump's administration. Meanwhile, due to concerns that the president-elect will impose broad tariffs on all U.S. trade, foreign currencies are falling against the dollar.

If the dollar continues to strengthen at its current pace through the end of the year, it could slow down earnings per share growth for multinational companies in the fourth quarter of 2024 and 2025, Morgan Stanley wrote.

Third, stocks are overvalued.

With bullish investors rushing to invest in AI-related market themes this year, the S&P 500 index has increasingly deviated from its fundamentals.

More specifically, the year-over-year change in the S&P index rarely diverges so much from earnings revisions, analysts wrote. Again, this is more a consideration for the major indexes rather than individual stocks, but it does suggest that further upward movement in P/E ratios may depend on whether data confirms a re-acceleration in economic growth.

Just as Morgan Stanley issued these warnings, the Trump trade has already cooled off. The three major U.S. stock indexes closed lower on Tuesday as investors took some profits from the post-election rally and anxiously awaited U.S. inflation data to be released this week. The S&P 500 index fell 0.29% to 5,983.99 points. A day earlier, the three major U.S. stock indexes all hit record highs, with the S&P 500 index crossing the 6,000-point mark for the first time.