Stocks are trying to find a way out of last week’s steep declines, but Morgan Stanley warns that these bailouts are fleeting and many more to come. “With valuations now more attractive and rates likely to stabilize below 3%, equities appear to have started a rally,” said Michael Wilson, director of US equity strategy at the firm. another key bear market,” Michael Wilson, chief US equity strategist at the company, said in a note to investors on Sunday. “We’re still confident that lower prices are still ahead,” he added. “In S&P 500 terms, we think that’s close to the 3,400 level, which is where both valuation and technical support lie.” The S&P 500 index edged up Monday afternoon in a round of consistent trading. The index ended the previous session at 4,023.89, down about 15% on the year. The primary concern for stocks has become growth rather than inflation, the Federal Reserve and interest rates. Stocks sold off in April, which is usually a strong month for stocks. Over the past week, the S&P 500’s price-to-earnings ratio has fallen as the equity risk premium (ERP) has risen sharply, while Treasury yields have fallen, Wilson found. The equity risk premium is the return generated by an asset relative to the risk-free rate of return. Initially, that situation was what Morgan Stanley strategists were waiting to call a bottom in this bear market. Even with that scenario playing out, however, stocks will still have room to fall before a meaningful recovery, according to Wilson. That’s because earnings risk lies ahead, he said, noting that although the second-quarter estimate for the S&P 500 fell, the full-year estimate was unchanged. The strategist sees that increasing the threshold for the second half of 2022, at which point the economy will feel the effects of higher rates and other headwinds. “The bottom line is that this bear market will not end until valuations drop to the (14-15x) level,” writes Wilson. “The question is will the stock market go ahead and ease the earnings cuts we think are coming or will it require companies to officially cut their guidance?” he say. “Given the prevailing bearish bias today and the extreme oversold conditions, we could see it play out either way.”
