The S&P 500 index could return to its pre-pandemic 3,400 level in the coming months that translates to another 15% downside from here, warned a Morgan Stanley analyst on Monday.
Don’t be fooled by the bear market rally
Michael Wilson dubs the recent bounce (about 4.0%) in U.S. equities a “bear market rally” and says investors should brace for more pain ahead as inflation and supply constraints remain a significant headwind. In his note, the analyst said:
With valuations now more attractive, equity markets so oversold an rates potentially stabilizing below 3.0%, stocks appear to have begun another material bear market rally. After that, we remain confident that lower prices are still ahead.
Last week, the U.S. Bureau of Labour Statistics said inflation stood at 8.30% in April – a marginal decline versus the prior month but still ahead of the Dow Jones estimate.
How to navigate the current environment?
Wilson continues to see a recession as unlikely, but agrees that the risk of such an economic downturn has certainly gone up. The U.S. economy unexpectedly shrank 1.40% in the first quarter of 2022.
That is just another reason why equity risk premium is too low, and stocks are still overpriced. The bear market won’t be over until valuations fall to levels (14 – 15x) that discount the kind of earnings cuts we envision, or earnings estimates get cut.
He recommends increasing exposure to real estate, health care, and utilities stocks to navigate the current environment, while tech and consumer discretionary stocks remain a big “no” for him.
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