Stocks rebounded from their recent slump on Monday, but some bearish Wall Street strategists still see concerns that aren’t going away anytime soon for investors.

With expectations that the Federal Reserve will cut interest rates fading, signs of inflation remaining sticky, and stocks still trading at higher-than-average valuations, many believe the market is in a similar position to where it stood entering a three-month downturn in the late summer and fall of 2023.

“Price action may depend on earnings and could stabilize near-term,” JPMorgan’s chief market strategist Marko Kolanovic wrote in a note on Monday. “Beyond this, however, we think the sell-off has further to go. We remain concerned about continued complacency in equity valuations, inflation staying too hot, further Fed repricing, and a profit outlook where the implied acceleration this year might end up too optimistic.”

“The current market narrative and patterns are increasingly resembling those of last summer, when upside inflation surprises and hawkish Fed revisions drove a correction in risk assets, but investor positioning now appears more elevated.”

At the end of summer 2023, markets became increasingly pessimistic about the Fed cutting rates. Investors interpreted comments Chair Jerome Powell made at the Fed’s September meeting last year to mean the central bank would likely hold interest rates higher for longer than many hoped. This weighed on stocks over the next month as bond yields soared.

At that time, Fed officials were still debating more rate hikes as economic data continued to come in hotter than expected. While hikes haven’t been suggested this time around, an increasing number of economists have floated the idea that the economy’s better-than-expected growth could prevent the Fed from reducing rates at all this year.

This has caused a familiar reaction in markets. As investors have scaled back their bets on rate cuts — with consensus shifting from expecting as many as seven cuts this year in January to now expecting less than two — bond yields have ripped higher, and stocks entered their worst drawdown of the year.

Julian Emanuel, who leads Evercore ISI’s equity, derivatives, and quantitative strategy, recently told Yahoo Finance that the current market action is reminiscent of what preceded last year’s pullback.

Emanuel has been closely watching the 2-year Treasury yield, which hit 5% a week ago — a critical level for investor sentiment — for the first time since November 2023. Stocks subsequently sold off. The 2-year Treasury yield closed at nearly 4.97% on Monday.

The move higher in the 2-year Treasury yield is of concern, per Emanuel, because stocks had been trading higher on the “implicit promise” of three Fed rate cuts this year.

“And if you look at it going back to March, I think it’s a lot more than a coincidence the market rolled over from the highs literally precisely the moment the market started pricing in fewer than those three promised cuts,” Emanuel said.

Morgan Stanley chief investment officer Mike Wilson wrote in a research note on Sunday that with the 10-year Treasury yield (^TNX) now handily above the critical level of 4.35% to 4.40%, higher yields could weigh on stock valuations moving forward.

“If yields stay at current levels over the next 3 months, multiples could face ~5% downside within that period all else equal (which would equate to 4700-4800 on the S&P 500),” Wilson wrote.

Wilson noted that with elevated yields, any move higher from here will “largely have to be earned through earnings upside rather than multiple expansion.”

Meta (META), Microsoft (MSFT), Alphabet (GOOGL, GOOG), Tesla (TSLA), and Chipotle (CMG) are all set to report earnings this week in a busy week for S&P 500 reporting.

Written by: Josh Schafer @Yahoo Finance

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