Stocks are still in a bear market and investors should sell the recent 'vicious' rally and get defensive, Morgan Stanley says

• Stocks remain in a bear market even last week's sharp rally, said Morgan Stanley in a note Monday.
• The Nasdaq Composite jumped 8.2% last week to mark its best performance since November 2020.

US equities just notched their best week in more than a year but Morgan Stanley warned investors on Monday that stocks are still in a bear market.

"Bear market rallies are the most vicious," wrote Michael Wilson, chief US equity strategist, at Morgan Stanley, with the note arriving after the Nasdaq Composite last week gained 8.2% and the S&P 500 advanced by 5.5%. The moves left the indexes with their strongest weekly performance since November 2020, when drugmaker Pfizer and its partner Bio-N-Tech announced the news about the first COVID-19 vaccine.

"While it could go a bit higher, led by the Nasdaq and small caps, we remain convicted it's still a bear market and we would use this strength to position more defensively," said Wilson in upgrading utilities to an overweight position and adding energy and natural gas utility CenterPoint Energy to its Fresh Money buy list.

The Nasdaq earlier this month slumped into a bear market as it lost 20% from its last high in November 2021 and the S&P 500 has been pushed into a correction after dropping 10% from its all-time high in January.

Morgan Stanley said its analysis suggests the next leg down for stocks should be completed by mid- to late-April. The Nasdaq and the small cap Russell 2000 may have more upside than the S&P 500 if the rally were to stretch into this week, in part as they are further below their respective 200-day moving averages.

"However, we want to be perfectly clear that both of these indices' relative strength have broken down, and until that changes, they are not attractive on a relative basis from an investment perspective beyond this technical bounce," said Wilson.

Morgan Stanley had remained neutral on utilities as it anticipated interest rates were still likely to rise into 2021 as the Federal Reserve shifted to a more aggressive policy stance in the face of high inflation. The rates view was correct, it said. However, waiting to upgrade utilities was a "mistake," in part as that sector has been the second-best performance since mid-November. But utilities can still provide good relative outperformance, it said.

"Bottom line, last week was nothing more than a vicious bear market rally, in our view, and while it may not be completely finished, it is a rally to sell," said Wilson.