Thomson Reuters
- The rally in stocks is a "bull trap" and investors have more pain coming, Morgan Stanley warned.
- That's because earnings-per-share estimates over the next year haven't bottomed yet, and neither have stocks.
- The downside could come as soon as March, as the S&P 500 is at a critical testing point.
The stock market rally in 2023 is a trap, and more pain is coming for investors in March, according to Morgan Stanley.
"With the equity market showing signs of exhaustion after the last Fed meeting, the S&P 500 is at critical technical support. Given our view on earnings, March is a high risk month for the bear market to resume," a team of strategists led by Mike Wilson said in a note on Monday.
"Ultimately, we think this rally is a bull trap," the note later added.
That comes after a strong start to the year for stocks, with the S&P 500 rising 9% by early February as investors hoped for a less hawkish Federal Reserve and a soft landing for the economy.
But most of the gains haven't been driven by fundamentals, Morgan Stanley said, warning that corporate earnings were still in danger. Though earnings-per-share forecasts over the next year have flattened, estimates are unlikely to bottom out until September, suggesting that stocks have yet to bottom as well, strategists added.
Previously, Wilson's team predicted an earnings recession akin to 2008 could ravage stocks as firms continue to battle high interest rates, and that the S&P 500 could crash as much as 26% in the coming months.
That downside could start as soon as March, the latest note said, as the S&P 500 is hovering around the critical level of 4,000, where it has been since late January.
If interest rates and the value of the US dollar start to ease, stocks could stage a "one last stand" that delays the eventual sell-off, Morgan Stanley said.
"Conversely, if rates and the US Dollar continue higher we think these key support levels for stocks will quickly give way as the bear resumes more forcefully. Bottom line, the US Dollar and rates could determine the short term path of stock prices while earnings will ultimately tell us if this is a new bull market or bull trap," strategists warned.
But bond yields and the dollar's value are influenced by the fed funds rate, and officials have signaled more rate hikes are coming in the following months. Markets are expecting a 25-basis-point hike at the central bank's next meeting, though bearish commentators say a 50-basis-point hike isn't off the table.