Morgan Stanley warns clients to prepare for a volatile December

Morgan Stanley equity strategists warned clients about potential volatility in the stock markets this month due to fluctuating rates.

Following November’s significant rally, stocks are reflecting the expectations that the Federal Reserve can implement rate cuts next year as inflation decreases within the remaining time of the business cycle.

“Specifically, 130bps of cuts are now priced into Fed Funds futures through the end of next year—a dovish expectation in the context of stable economic growth in 2024,” the analysts said in a report.

The analysts note that large caps historically outperform small caps before and after the initial rate cut is delivered. While the market has priced in a Fed pivot several times over the past year, the latest pricing has gained the most support from investors.

The analysts suggest waiting for a more opportune entry point later this month to participate in a seasonal rally in small caps instead of chasing the recent outsized move.

“In our view, December may see some near term volatility in both rates and equities before more constructive seasonal trends for equities and market expectations of a potential ‘January Effect’ have an impact.”