Morgan Stanley says beware bear market rallies, S&P 500 headed to 3,400
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Although stocks are trying to recover from last week’s severe losses, Morgan Stanley warns that such relief rallies can be short-lived and will lead to more falls. According to Michael Wilson (chief U.S. equity strategist), stocks are now in an attractive valuation, as equity markets have become so saturated and interest rates below 3%, this suggests that there has been a material bear market rally. He said, “After this, we remain confident in the fact that lower prices will still be ahead.” “In S & P 500 terms we think that level is close to 3,400, which is where both valuation and technical support lie.” The S & P 500 climbed slightly on Monday afternoon in a bout of fitful trading. It ended its previous session at 4,023.89. This was a drop of around 15%. Stocks’ primary concern has been growth, not inflation, and the Federal Reserve as well as interest rates. In April, which is a traditionally strong month for stocks, stock prices fell. In the past week, the S & P 500’s price-to-earnings ratio contracted due to the sharp rise in equity risk premiums (ERP), while Treasury yields fell, Wilson found. The return that an asset generates over its risk-free return is called equity risk premium. Morgan Stanley strategists waited for this situation to signal a bottom in the bear market. Wilson said that even though this scenario is now over, stocks have more to fall before there’s a significant rebound. That’s because earnings risk lies ahead, he said, noting that while second-quarter estimates for the S & P 500 came down, full-year estimates were unchanged. This raises expectations for 2022’s second half, when the economy will feel the impact of higher interest rates. Wilson stated that the bear market won’t end until valuations drop to 14-15x that are low enough to discount any earnings reductions we see or that earnings estimates fall. The question now is whether the equity market will continue to discount earnings cuts that we expect or if it will require companies and individuals to reduce their guidance. He stated that he was confident. He said, “Given our pervasive bearishness and the extreme oversold circumstances now, it could play out any way.”
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