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S&P 500's Deeper Valuation Correction Signals Potential Market Comeback

The S&P 500 avoided a 10% correction with a 1.2% rally on Monday, but Morgan Stanley's Michael Wilson argues that a 15% drop in the forward P/E ratio from October highs indicates a deeper valuation correction. Accelerating earnings growth, now near 20%, supports a potential sustained recovery. Short-term gains were boosted by U.S.-Iran negotiations, though the index remains down for the year. Wilson compares the current pullback to past corrections but highlights the unique strength in earnings. Historical data suggests stocks perform well during earnings acceleration, boding well for future returns.

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S&P 500's Deeper Valuation Correction Signals Potential Market Comeback

The S&P 500's 1.2% rally on Monday helped it avoid a 10% correction, but a sharper decline in valuations suggests a more advanced pullback that could fuel a sustained recovery, according to Morgan Stanley strategist Michael Wilson.

Market Rebounds from Correction Threshold

  • The S&P 500 rose 1.2% on Monday following a 1.5% drop on Friday, which had nearly pushed the index into a 10% correction from its recent peak.
  • Despite the rebound, the broad index remains down nearly 4% for the year 2026 and almost 2% from a week ago.

Valuation Decline Outpaces Price Drop

  • Wilson emphasized that the S&P 500's forward price-to-earnings (P/E) multiple fell 15% from its October high, revealing a correction more severe than price movements alone indicate.
  • This valuation drawdown is comparable to the 2015 manufacturing slowdown and the 2023 recession scare, but differs due to accelerating earnings growth.
  • "Those who claim the equity market is complacent are likely only considering price as opposed to looking at valuations," Wilson stated.

Earnings Acceleration Underpins Optimism

  • Forward earnings growth has sped up to nearly 20%, providing a foundation for continued market expansion, Wilson noted.
  • Historical analysis shows that during periods of accelerating earnings and positive EPS revisions, stocks typically gain 3% in one month and 9% over the next year.
  • Wilson asserts that the current business expansion is resilient, with oil price spikes unlikely to derail growth given strong earnings momentum.

Short-Term Drivers and Market Outlook

  • The Monday rally was partly driven by news of productive U.S.-Iran talks and a U.S. suspension of attacks on energy infrastructure for five days.
  • Wilson cautions that the market's valuation adjustment implies it has already priced in an excessive deceleration in growth.
  • "In other words, the market, via valuations, always gets in front of the change in growth," he added, suggesting the pullback may be overdone.
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