US equities remain susceptible to further increases in energy prices and turbulence within the bond market, according to strategists at Morgan Stanley, who highlight a scenario where the S&P 500 could decline by as much as 7%.

The team, led by Michael Wilson, noted that while robust corporate earnings have so far helped share prices withstand rising bond yields, the valuation of the S&P 500 has slipped to its lowest level since March over the past four months. "If the recent valuation correction worsens due to tighter financial conditions and/or a sharp spike in energy prices, we believe the S&P 500 could fall to as low as 7,100 points before a year-end bull market resumes," Wilson wrote in a note. That level implies a 7% drop from the index's closing price on Friday.

Wilson also anticipates heightened market volatility as the November midterm elections draw closer, but ultimately expects that strong corporate earnings prospects will fuel a year-end rally, pushing the index toward his 8,000-point target. This would represent a gain of nearly 5% from current levels.

Since hitting a record high in mid-August, the S&P 500 has traded erratically, influenced by concerns over the inflation outlook and the 10-year Treasury yield hovering around 5%. WTI crude oil futures have eased back to roughly $100 per barrel, yet they remain 43% higher than the lows seen in July. The Federal Reserve last week implemented its first interest rate hike in three years. Even so, investor optimism persists, supported by the central bank's dedication to fighting inflation.

The benchmark index sits only about 2% below its peak, buoyed by what was one of the strongest quarterly earnings seasons on record in the second quarter. Market strategists at firms including JPMorgan and Goldman Sachs also argue that stocks should continue to benefit from solid earnings performance. However, the team at Bank of America cautions that investor positioning remains overly bullish given the deceleration in earnings growth.

Morgan Stanley's Wilson has stood out as one of the more bullish voices on US equities this year. He reiterated his recommendation for large-cap quality stocks and stated that momentum is building in service-oriented and asset-light industries.