There is more pain in the pain trade ahead.
That is according to Michael Wilson, Morgan Stanley’s chief U.S. equity strategist, who said, during an interview on CNBC midday Thursday, that a current market rebound belies a market that is badly damaged and ready to sink further.
Wilson describes current conditions as a “rolling bear market,” which began in February, and predicted that the S&P 500 index SPX, +1.86% could fall to between 2,450 and 2,500. That represents a roughly 8% to 10% drop from the broad-market benchmark’s current levels. “And we think we get their in four to eight weeks,” Wilson said.
Morgan Stanley defines a bear market as a selloff of 20% or more, with no recovery within 12 months.
“Risk-reward remains unattractive for us,” he said. The Morgan Stanley analyst added that the current slump in stocks that wiped out the year-to-date return in the S&P 500 and the Dow Jones Industrial Average DJIA, +1.63% in a powerful move lower on Wednesday, “may last a bit longer.”
Wilson said the “rolling bear market” taking shape is fueled by evaporating global liquidity as the Federal Reserve and central banks elsewhere are pulling back on crisis-era monetary policy and attempting to normalize their respective economies. He said “a lot of damage” has been done and said 80% of the rout may be complete.
Back in September, Wilson was making ominous calls even as U.S. stocks were recovering from their February corrections, where the S&P 500 and the Dow fell 10% from their late-January peak.
At that time, Wilson pointed to a divergence in credit spreads and equity values as early evidence of a change in the market’s complexion.
“Divergences between equity markets and breadth or credit spreads can also persist for longer than one can stomach before they are resolved. The bottom line is they look to us like clear signals that nice weather may not be the right forecast,” Wilson said in a September note.
In July, Wilson predicted that the market would see its largest correction in months, with the rally showing signs of “exhaustion.” He wrote then: “The bottom line for us is that we think the selling has just begun and this correction will be biggest since the one we experienced in February.”
He warned that the coming downturn could disproportionately hurt investors who are heavily weighted in technology and internet-related names, including some of the so-called FAANG names that have been at the center of the recent uptrend in the market by dint of their advances year-to-date and their total market weight. FAANG is an acronym for popular, large-cap tech stocks consisting of Facebook Inc. FB, -2.23% Apple Inc. AAPL, -0.81% Amazon.com Inc.AMZN, -7.64% Netflix Inc. NFLX, -3.11% and Google-parent Alphabet Inc.GOOGL, -3.08%
On Thursday, the technology-laden Nasdaq Composite Index COMP, +2.95%which tumbled into correction territory on Wednesday, enjoyed the sharpest rebound among peer benchmarks, up 2.5%, after it fell more than 4%, representing its worst single-session decline since Aug. 18, 2011, according to FactSet data.
But if Wilson is correct, investors aren’t out of the woods yet.
The U.S. trade clash with China, which is beginning to be discussed more frequently by U.S. corporate executives on earnings calls, is among the factors market participants point to as a key catalyst for the current downbeat mood.
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— Alastair Williamson (@StockBoardAsset) October 24, 2018