MORGAN STANLEY: Here's what needs to happen before we can 'blow the all clear signal' for stocks
- Morgan Stanley equity strategists think stocks will rise 8% into year-end.
- But they need to see a few developments, including a pause in the Federal Reserve's interest-rate hiking path, before deeming a sustained stock-market bottom.
- US equity markets have posted modest gains so far this year.
Morgan Stanley's equity strategists are positive stocks will end the year higher. But with so much uncertainty looming on the horizon, they need to be convinced of a few things before declaring stocks are out of the woods.
"We are definitely more constructive than we have been in over a year based on valuation, sentiment, and positioning, but we don't think it is time to blow the all clear signal yet," a team of equity strategists led by Michael Wilson told clients in a note on Monday.
"Multiples across the globe are well below 5-year averages and the equity risk premium in the US reached levels last seen in early 2016. However, we don't expect this slowdown to be as severe, suggesting it's priced at the index level."
Wilson and his team have a year-end price target of 2,750 on the S&P 500, implying a rise of nearly 8% from Monday's closing price. The S&P 500 has posted a gain of 1.6% so far this year despite volatility produced by ongoing trade negotiations between the US and China, the government shutdown, and Apple's quarterly revenue warning last week.
Here's a breakdown of some developments Morgan Stanley identified which would lead them to believe stocks can meaningfully bottom at this juncture.
- Work off technical damage. The market has experienced "significant" technical damage, Morgan Stanley said. For example, just under 20% of S&P 500 members are trading above their respective 200-day moving averages - a dismal reading near an eight-year low. Additionally, the S&P 500 itself is trading meaningfully below its own 50- and 200-day moving averages. "There is quite a bit of overhead resistance that will need to be worked through," they said.
- An increasingly dovish Fed. The strategists said the Federal Reserve needs to shift from an increasingly dovish tone to "more dovish action," like halting its interest-rate hiking path and/or reducing its balance sheet. Until then, Wilson's team thinks "it will be hard to sustain a rally much above the old support of 2600-2650."
- Digesting negative numbers. Investors have to "get past some incrementally negative data points" weighing on the market like last week's disappointing ISM purchasing managers index data and Apple's quarterly revenue warning. Morgan Stanley said those two events were "unlikely isolated incidents."
- Hedge funds are bearish, but not bearish enough. The strategists' internal hedge-fund data shows exposures have not been this low since 2016 on a net basis, and 2012 on a gross basis. While this shows investors are "appropriately bearish," and gives Morgan Stanley reason to grow more constructive at this point, sentiment has not become extreme enough to call for a sustainable market bottom.
Morgan Stanley's price target for its "bull case" is 3,000, implying a rise of nearly 18% from current levels. Its "bear case" of 2,400 implies a drop of 6%.
Read more: JPMORGAN: These 2 charts show a blistering stock market rebound is just getting started
More granularly, the firm recommends overweight positions in consumer staples, energy, financials, and utilities. It recommends underweight positions in consumer discretionary and technology.
When it comes to preference for value stocks over growth stocks, the firm prefers value due to its view that value is cheap relative to history. "Growth stocks can still work as long as you don't overpay for them," they conclude.
Now read:
- The best-performing investment of 2018 came as a shock to everyone - and the stars are now aligned for its continued dominance
- A group of Wall Street firms are planning to launch a stock exchange that should 'scare the living daylights out of NYSE and Nasdaq'