U.S. stocks could extend their defiant rally, which has lifted the S&P 500 to solid year-to-date gains in the face of surging bond yields and a hawkish Fed, for a least a few more weeks, according to one of Wall Street's most-notable bear market prognosticators.
Morgan Stanley's Michael Wilson, who recently warned that the S&P 500 could face a 26% drawdown into the month of March as the Fed consolidates its interest rate tightening cycle and corporate earnings slide into recession, now suggests the market's resilience could delay that slump for at least a few more weeks.
Wilson said the S&P 500's key support levels have been severely tested over the past few weeks, including a slip below its 200-day moving average -- a closely watched indicator of equity market momentum -- but on Friday, the market reacted strongly around the second test" as it rallied 1.61% to close at 4,050.64 points, with a further 8.3 point advance on Monday, and extend its year-to-date gain to around 6%.
"We have to respect that successful test and now need to try and decide what it means,” Wilson said in a Monday client note. "It is critical that the S&P 500 get back above (the current trendline, and rise to around 4,150 points) to confirm a new bull market," he said. "Our view remains the same: the bear market is not over, but we acknowledge that Friday's price action may extend it a few more weeks. Time will tell.”
Treasury Yields Firmly in Focus
Wilson's latest assessment, while not entirely a u-turn from his previous forecast, seems to at least acknowledge the market's linkage to Treasury bond yields.
Bond yields pushed stocks lower in the middle of last week after 10-year notes breached 4% for the first time since November, then allowed stocks to rally sharply on Friday as they retreated to 3.915%. That move followed data from the ISM services sector index that showed solid growth with elevated -- but not accelerating -- input-price pressures.
Treasury yields were muted again Monday, in fact, following weekend comments from San Francisco Fed President Mary Daly. During a weekend speech at at Princeton University he echoed some of her colleagues in suggesting that she favors smaller hikes over a return to outsized increases.
"Last week ended the S&P 500's string of three consecutive down weeks, and while the index’s net decline was much smaller than other recent three-week downturns, snapping the losing streak hasn’t necessarily resulted in an uninterrupted rally," said Chris Larkin, managing director for trading at E-Trade from Morgan Stanley.
"Traders are still anticipating a 25-basis point hike in a few weeks, and investors should prepare for volatility if the jobs read surprises in either direction, especially as some Fed officials have indicated a 50-basis point hike remains on the table."
The lower opening yields may also reflect the softer-than-expected GDP growth target unveiled Sunday by China Premier Li Keqiang at the start of the country's annual 'two sessions' meeting of the National People’s Congress and the Chinese People's Political Consultative Conference.
Li Keqiang set a growth target for the world's second-largest economy of 'around 5%' in his annual in the Government Work Report, firmly shy of analysts' estimates and one of the weakest in decades. The weaker-than-expected GDP target could suggest softer commodities demand, and easing inflation pressures, over the coming months .
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Benchmark 10-year note yields were marked at 3.911% in overnight trading, with 2-year paper easing 4.834%, while the U.S. dollar index edged 0.04% lower against its global peers to 104.478.
Earnings Recession Looms
Stocks are still vulnerable to the impact of Fed tightening, however, given the fact that the S&P 500 is trading at multiple to earnings of around 18 times, around 20% ahead of its longer-term trend, and collective corporate profits are heading firmly into a downturn.
With only a handful of companies in the benchmark set to report earnings this week, and 493 holiday quarter reports in the books, collective S&P 500 profits are set to decline by 3.2% from a year earlier to a share-weighed $440.9 billion.
That tally accelerates to a decline of 4.5% for the three months ending in March, according to Refinitiv data, to a share-weighted $423.4 billion.
Bank of America's closely tracked Flow Show report also noted another $7.4 billion pullback from U.S. equity funds, with around $8.4 billion finding its way into fixed-income funds.
Respondents also linked a 4% 10-year Treasury note yield with a 3,800 price target on the S&P 500, suggesting another 5.3% pullback from current levels if markets continue to price in further Fed rate hikes.
Those conditions, Wilson of Morgan Stanley said, will likely mean that any extension of the current bear-market rally, which has lifted stocks some 13.1% from their October lows, has only a few more weeks to run.
“We believe it does not refute the very poor risk-reward currently offered by many stocks given valuations and earnings forecasts that remain way too high, in our view,” Wilson said.
