Markets May Be 'Tiptoeing' Into Valuation Shock, Morgan Stanley's Caron Says

Summary

• Markets are dominated by geopolitical headline risk, especially heading into weekends, prompting risk-off behavior.
• Surging oil prices are triggering a price shock, depressing equity prices as higher rates increase the discount on future cash flows.
• Core debate centers on whether the shock remains temporary (price shock) or escalates into a prolonged valuation shock with deeper economic impact.
• Caron's base case is a price shock, but observes yield curve steepening (2-year yields down, 10-year yields up) as a potential early signal of markets "tiptoeing" toward valuation shock.
• Strong pre-conflict economic fundamentals provide resilience, though growth may be interrupted rather than derailed.
• Friday trading often sees exaggerated downdrafts due to weekend uncertainty, with frequent rebounds on Monday if no new negative events occur.
• Geopolitical tension involves "negotiated escalation," where military posturing may precede settlement, a dynamic difficult for markets to price.
• High uncertainty regarding conflict duration and intensity necessitates a wait-and-see approach, with limited data to assess recession risk.