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The stock bear market is far from over, but conditions suggest a rip higher could be in the cards, Morgan Stanley says.
“In last week’s note, we suggested the bear market was entering the phase when virtually nothing would work, even defensives,” strategist Mike Wilson wrote in a note Monday. “Based on the price action we got, it’s fair to say that’s exactly what happened.”
“On the positive side, the market is currently so oversold, any good news could lead to a vicious bear market rally,” Wilson said. “We can’t rule anything out in the short term but we want to make it clear this bear market is far from completed, in our view.”
From a technical standpoint the S&P 500 (SP500) (NYSEARCA:SPY) has minimum downside near term, he said.
“This represents 16x forward 12 month bottoms up consensus EPS which is looking more at risk now,” he said. “In other words, 16x is fair value but if forward EPS starts to fall, there could be much more downside. As we highlighted back in January, true technical support lies at the 200 week moving average if there is going to be a true growth scare with recession probabilities rising materially.”
“Unfortunately, that currently comes in at 3460, or -16%. It also lines up with the pre pandemic highs of 3400 which seems to be where a lot of stocks have already ventured. In many ways, this makes perfect sense from the point of view that the pandemic did not create real value for the economy or most companies, but rather destroyed it.”
Stocks may no longer be the inflation hedges investors expect, Wilson added.
“Rising inflation should theoretically pass through to top-line growth, making stocks a historically safe bet against inflation. Why is this time different? Valuations are still near their highest levels ever as shown by the earnings yield … and subtracting inflation gives you a real negative earnings yield. This theoretically means you’re buying -4% earnings contraction at today’s levels.”
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