Recent observations by Morgan Stanley (MS, Financial) highlight a concerning trend in the U.S. stock market: despite indices maintaining near-record highs, market breadth is at historically low levels. This suggests that the Federal Reserve may not provide as much easing as the market anticipates. Growth stocks with high valuations but low profitability, along with low-quality cyclical stocks, are particularly vulnerable to reduced liquidity.
Market breadth deterioration began in early December, coinciding with a rise in the 10-year U.S. Treasury yield. When yields exceed 4.5%, they pose resistance to stocks, turning the correlation with stock P/E ratios negative. Investors' focus on price momentum and reduced emphasis on rebalancing have led to extreme market concentration.
Liquidity excesses are fading, raising questions about future market dynamics. If liquidity tightens, the observed breadth-price anomaly might normalize. Conversely, unexpected Fed rate cuts could sustain liquidity strength.
