The tech-heavy Nasdaq could plunge another 12% from current levels as a key support level is tested, says Morgan Stanley's investment chief
- As investors continue to grapple with a rise in COVID-19 cases and the uncertainty of more fiscal stimulus from Congress, the technical picture of the stock market "has deteriorated," Morgan Stanley said in a note on Monday.
- After both the S&P 500 and Nasdaq 100 indices closed below their respective 50-day moving averages, the next level of support investors should watch is the 200-day moving average, according to the note.
- A continued market sell-off to the 200-day moving average would represent downside potential of 5% and 12% in the S&P 500 and Nasdaq 100, respectively, based off of Monday's closing prices.
- "Speculation needs to be wrung out before the bull market can continue," Morgan Stanley said.
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The stock market's current correction may have more room to go from a technical perspective as investors turn their attention to rising COVID-19 daily cases and uncertainty from Congress on another fiscal stimulus package.
That's according to Morgan Stanley's Mike Wilson, who highlighted in a note on Monday that the "technical picture has deteriorated, especially for the Nasdaq 100," according to the note.
The main issue is that both the S&P 500 and Nasdaq 100 closed below their 50-day moving averages after enjoying a steady, albeit overextended, uptrend.
Now, the market's next level of key support is the 200-day moving average, which represents downside potential of 5% and 12% for the S&P 500 and Nasdaq 100 indices, respectively, based on Monday's closing prices.
While Morgan Stanley still sticks by its view that stocks are in the early days of a new bull market, the tech-heavy index remains especially vulnerable to continue its correction to the 200-day moving average.
"Speculation needs to be wrung out before the bull market can continue," Wilson said.
Based off of the CNN Fear & Greed Index, investor sentiment has taken a hit. The sentiment indicator closed in neutral territory on Monday with a read of 51, a noticeable decline from a week's earlier reading of 59, which is considered greed territory.
Still, don't expect the stock market to make new record highs before year-end.
"We think the major averages may struggle through year end to make new highs as valuations come down faster than EPS estimates can rise," the note said.
Morgan Stanley notes that the September 2 high near 3,550 in the S&P 500 lines up with two converging trend lines.
First is a rising trend line derived from the March 2009 bottom, and more notably, there is a more than three-decade rising resistance trend line that starts at the 1987 top, and touches both the dot-com bubble top in 2000 and a "failed breakout" top on September 2.
Additionally, the underperformance of the Nasdaq 100 relative to the S&P 500 suggests "the correction isn't over" after the ratio put in a "blow off top" in August, according to the note.
But investors shouldn't be surprised.
"This is what happens when stocks get so extended — corrections can be much bigger while remaining in an uptrend," Wilson explained.