S&P 500 Rally Just a Bear Market Bounce: Morgan Stanley

John Smith

The S&P 500 Index posted its best weekly gain in over a year last week, but Morgan Stanley’s chief equity strategist, Michael Wilson, believes the rally was just another bear market bounce rather than the start of a sustained upswing.

In a research note on Monday, Wilson said the index’s 6% gain last week lacks the technical and fundamental support needed for a more lasting rebound. He cited the gloomy earnings outlook, weaker economic data, and deteriorating analyst views as reasons to doubt the rally’s staying power.

“We find it difficult to get more excited about a year-end rally,” Wilson wrote. “While this oversold bounce was expected, it looks more like a bear market rally rather than the start of a sustained upswing.”

Driving Last Week’s Rally

Last week’s rally came after Federal Reserve Chair Jerome Powell indicated the central bank may be nearing the end of its aggressive interest rate hiking campaign. Powell said the Fed could slow the pace of rate increases as soon as December.

The dovish tone sparked investor hopes for a soft economic landing, lifting the S&P 500 and tech-heavy Nasdaq 100 by around 6% on the week. The yield on the benchmark 10-year Treasury note also dropped as recession fears ebbed.

But Wilson believes the market misinterpreted Powell’s remarks. He said the drop in Treasury yields had more to do with lower coupon issuance guidance and weak economic data rather than faith in an imminent Fed pivot.

“The drop in Treasury yields was more related to the lower than expected coupon issuance guidance and weaker economic data as opposed to the bullish interpretation (for equities) that the Fed is going to cut rates earlier next year,” Wilson explained.

Earnings Outlook Remains Gloomy

Wilson has maintained a stubbornly bearish outlook on stocks all year, even as the market rebounded from its mid-June lows.

One of his main concerns continues to be corporate earnings. With nearly 300 S&P 500 companies having reported third quarter results, earnings are on track to decline by around 2.2% year-over-year. Looking ahead, Wilson sees fourth quarter earnings dropping by 5-10% and estimates full-year 2023 earnings will fall by 4%.

The gloomy profit outlook reflects deteriorating macroeconomic conditions as the Fed’s aggressive rate hikes work their way through the economy. Higher interest rates make borrowing more expensive for consumers and businesses, slowing demand. Meanwhile, the surging dollar has hurt overseas profits for multinational companies.

On top of the fundamental challenges, Wilson noted that Wall Street analysts have steadily reduced their S&P 500 earnings estimates in recent months.

“Importantly, negative estimate revisions continue to dominate now and analyst views seem just as poor as the economic data,” he wrote.

The Risk of Recession

While Fed officials have expressed optimism about engineering a soft landing, Wilson is skeptical the central bank can tame inflation without triggering a recession.

“The Fed is tightening into what will likely be a recession at some point in 2023,” he said.

Wilson expects the Fed to hike rates to a range of 5-5.25% by early next year. But with monetary policy still restrictive in 2023, he believes earnings expectations remain too high and sees further downside ahead for equities.

“With most economic indicators continuing to decelerate along with earnings expectations, we think it will be very difficult for the S&P 500 to stay above 4000,” Wilson warned.

The index closed last week around 3,992, having bounced 15% off its mid-October low. But Wilson believes the bear market is not over yet, forecasting the S&P 500 could fall to a low of 3,000-3,300 sometime in the first half of 2023.

That view puts him at odds with investors hoping the latest rally marks a sustained turnaround. But Wilson is sticking to his guns, arguing last week’s gain is just another head fake in the ongoing bear market.

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John Smith is a veteran stock trader with over 10 years of experience in the financial markets. He is a widely followed market commentator known for his astute analysis and accurate predictions. John has authored multiple bestselling books explaining complex market concepts in simple terms for novice investors looking to grow their wealth through strategic trading and long-term investments.
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