News & analysis
Morgan Stanley: Earnings Carry S&P 500 as Energy and Rates Weigh on Valuations
The bank says profit revisions are broadening fastest among large caps, leaving higher crude and refined product prices as more of an inflation problem than a growth threat.
Key points
- Morgan Stanley says earnings strength is offsetting valuation pressure from higher energy prices and rates, leaving the S&P 500 roughly flat since early June.
- The bank reports EPS revision breadth improving faster for the S&P 500 at 25% than for the Russell 2000 at 7%, which it calls classic mid-cycle behavior.
- Morgan Stanley views higher crude and refined product prices as more of an inflation risk than a growth risk given the strength of the business and earnings cycle.
The S&P 500 has made little headway since early June, but the composition of the market has shifted materially beneath the surface, with earnings strength absorbing the pressure that higher energy prices and interest rates are putting on valuations, Morgan Stanley said in a research note.
The bank's read on the split between earnings and valuation is that profit growth is doing the heavy lifting while higher energy prices and rates compress the multiples investors are willing to pay. That framing puts the burden of holding the index near its recent range on continued earnings delivery rather than on multiple expansion.
Revision breadth is improving unevenly. Morgan Stanley puts the share of S&P 500 companies seeing upward earnings revisions at 25%, against 7% for the smaller, lower-quality Russell 2000, where revisions are lagging. The gap matters because it concentrates the improvement in large caps rather than spreading it across the market.
The firm expects that revision strength in the S&P 500 to translate into a catch-up in performance, and describes the pattern as classic mid-cycle behavior consistent with the hotter-but-shorter cycle framework it introduced during the pandemic.
On the inflation channel, Morgan Stanley argues that higher crude prices, and refined product prices in particular, pose more of a risk to inflation than to growth, given the strength of the business and earnings cycle. That distinction implies the pressure would show up in price data and rate expectations rather than in an immediate hit to corporate profits.
