Morgan Stanley strategists cautioned that US equities are under dual pressure from further advances in energy prices and bond market volatility, with the S&P 500 facing a potential decline of up to 7% in the near term.

Michael Wilson, who leads the team, noted in his latest report that if financial conditions tighten further or energy prices spike significantly, the S&P 500 could fall to 7,100 points. That level sits roughly 7% below the index's closing price last Friday. Despite this, Wilson maintained his bullish stance into year-end, projecting that strong corporate earnings would drive a late-year rally, with a target of 8,000 points, representing a gain of nearly 5% from current levels.

The S&P 500 has been range-bound since hitting a record high in mid-August, weighed down by uncertainty over the inflation outlook. The 10-year Treasury yield hovers near 5%, and the Federal Reserve completed its first interest rate hike in three years last week.

Valuations Under Strain, But Bull Market Foundation Intact

Wilson stated that while robust corporate earnings have helped shares remain resilient amid higher bond yields, the S&P 500's valuation multiple has dropped to its lowest level since March over the past four months.

"If the deterioration in valuation multiples worsens due to tighter financial conditions and/or a significant surge in energy prices, we believe the S&P 500 could slide to 7,100 points before the bull market resumes at year-end," he wrote in the report.

Wilson also expects market volatility to increase ahead of the November midterm elections, but he ultimately remains constructive on the earnings outlook as a pillar of support for the year-end move.

Energy and Bond Market Pose Key Near-Term Risks

Energy prices represent a major variable for the current market landscape.

West Texas Intermediate (WTI) crude has retreated from above $100 per barrel, yet it remains roughly 43% higher than its July low, keeping persistent pressure on inflation expectations and corporate costs.

Meanwhile, the Fed's commitment to fighting inflation keeps the bond market on edge, with the 10-year Treasury yield holding near the elevated 5% level, pressuring equity valuations. Wilson pointed to further tightening in financial conditions as one of the key risk factors that could trigger a deeper correction.

Earnings Support Meets Diverging Market Views

Currently, the S&P 500 sits only about 2% below its record high, with a stellar second-quarter earnings season providing significant support for share prices.

In terms of market perspectives, JPMorgan and Goldman Sachs also argue that healthy corporate profits will continue to underpin equities. However, according to media reports, the strategy team at Bank of America (BofA) warns that investor positioning remains overly bullish as earnings growth decelerates.

Wilson reiterated his recommendation for large-cap high-quality stocks in the report, noting that momentum is strengthening in service-oriented and asset-light industries.