Morgan Stanley Sees Rates Risk to Stocks. Bank of America Says Not So Much

A pair of Wall Street’s most prominent US equity strategists are at odds about whether stocks can extend this year’s rally against the reality that interest rates will remain higher for longer.

Morgan Stanley’s Michael Wilson, an unwavering equity bear, says the correlation between real rates and equity returns has fallen deeper into negative territory — a sign that interest rates have once again become a determinant of stock performance. At Bank of America Corp., however, Savita Subramanian thinks equity markets can still thrive if rates remain elevated.

“Since mid-July, stocks have experienced a distinct change in personality,” Wilson wrote in a note to clients dated Oct. 1. He added that the leg lower in US equities following the latest Federal Reserve meeting last month suggests investors are “beginning to question the ‘higher for longer’ narrative.”

Wilson, who correctly called 2022’s stock market rout but failed to predict this year’s rally, has been vindicated by weakness across US stocks since the summer. The S&P 500 Index logged back-to-back drops in August and September, paring some of its double-digit gain this year.

In contrast, BofA’s Subramanian sees reasons to be bullish even if borrowing costs stay high. For starters, 50% more large-capitalization companies have dwindled into small caps than vice versa, a reversal from prior decades — and a sign that higher costs of capital have “purged weaklings,” with the attrition leaving the S&P 500 in “good shape.”