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Market correction was just an 'appetizer' for what’s to come later this year, Morgan Stanley says

Fred Imbert

The market correction experienced earlier this month was just a prelude of what's to come later in 2018, a Morgan Stanley strategist says.

On Feb. 8, the Dow Jones industrial average , S&P 500 and Nasdaq composite all closed about 10 percent below record highs set Jan. 26, notching the first pullback of that magnitude since 2016.

Andrew Sheets, chief cross-asset strategist at Morgan Stanley, said in a note Monday that those declines were just an "appetizer, not the main course."

"Our cycle models suggest that [developed markets] remain in the late stages of a late-cycle environment," said Sheets. "Rising equities, rising inflation, tightening policy, higher commodity prices and higher volatility are (in our view) a pretty normal pattern if that view is correct."

The benchmark 10-year U.S. note yield rose to a four-year high last week, while the short-term two-year yield reached its highest level since 2008 on Tuesday. Fears of rising inflation, along with worries about tighter monetary policy from the Federal Reserve , lifted rates and pressured stocks during the correction.

Last week, the Labor Department said the U.S. consumer price index — a widely followed inflation metric — rose 0.5 percent last month , topping a Reuters estimate of 0.3 percent.

"At present, the strength of current data … is still acting as a counterweight to inflation concerns, as is a strong 1Q results season. Earnings reported so far have beaten estimates by [about] 5% in the US," said Sheets. "Things get trickier, however, after 1Q. Past March, markets will need to digest rising … core inflation and declining [purchase manager indexes], economic surprises and (quite possibly) earnings revisions."

— CNBC's Pippa Stevens contributed to this report.

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