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Stocks had a strong start to the year, but experts warn there could be more trouble ahead for investors.

The S&P 500 has had a rough week as of midday Thursday, with four back-to-back losing sessions. The benchmark index is still up about 4% since the beginning of January, but there’s no guarantee those gains will last.

That's according to Morgan Stanley analysts. In a note to clients earlier this week, the analysts — led by Michael Wilson, chief equity strategist at the firm — warned that stocks have surged to unsustainable highs.

Investors are increasingly bullish across the board despite the facts that stocks are “more expensive than at any time since 2007” and earnings expectations are 10% to 20% too high, the analysts wrote.

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What’s ahead for the stock market

That mismatch between the state of the market and investors' optimistic sentiment could lead to major losses in the months to come, especially given that the Federal Reserve could raise interest rates higher than expected and keep them there longer than expected, according to the analysts.

The Fed raised interest rates throughout 2022 in an attempt to curb record-high inflation. Because higher interest rates make it more expensive for businesses and consumers to borrow and spend money, rate hikes tend to weigh on the price of financial assets like stocks, bonds and crypto — an effect we certainly saw reflected in the markets in 2022.

The central bank most recently raised the federal funds rate by 25 basis points. While that was a smaller increase than investors have grown accustomed to, minutes from the meeting released this week indicate that Fed officials believe ongoing rate increases will likely be necessary to fight inflation.

“Bottom line, investors are not bearish any longer,” the Morgan Stanley analysts wrote. “This is just another reason to be wary of the set-up going into what is likely to be another weak earnings season.”

Wilson predicts that the S&P 500 could potentially fall to as low as 3,000 points in the first half of the year. That’s a drop of nearly 25% from its close at 3,991 points on Wednesday.

Advice from Money

Fluctuations in the stock market are normal, and no one has a crystal ball when it comes to stocks’ performance. That’s one reason why financial advisors generally recommend deciding on a long-term investment strategy and sticking with it, even during periods when the market is down.

In fact, periods in which prices are lower are actually a good time to invest, many experts say, since stocks are essentially on sale and you can benefit from the eventual recovery. They tend to recommend a strategy like dollar-cost averaging, which involves investing set amounts of money at regular intervals, to keep yourself from trying to time the market.

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