Morgan Stanley
  • Wealth Management
  • Aug 23, 2022

Why the Market Surge May Not Last

As U.S. stocks have raced upward, are investors seeing the start of a sustainable bull run? Three reasons to remain cautious.

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U.S. stocks have been on a striking rally since mid-June—a welcome respite for weary investors after the most bruising first half in over 50 years, as inflation, rising interest rates, geopolitical conflict and other factors combined to drive a market rout.  

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The last two months’ recovery has sent the S&P 500 Index up about 15% from its June low. Catalyzing the rally was hope that the Federal Reserve’s 75-basis-point interest-rate hike in July might be the peak in its hawkish policy. Since then, data that inflation may be cooling—including the latest consumer and producer price index readings—has helped sustain market momentum. Now, some commentators seem eager to declare a new bull run.

As enticing as this rally has been, however, Morgan Stanley’s Global Investment Committee remains convinced that it is still no more than a bear-market rally. Here’s what to consider before rushing to chase the momentum:

  • It’s not unusual for stocks to rally during a bear market. In fact, rallies have occurred in just about every bear market of the past 95 years, with gains averaging 18% before a downward slide resumes. In comparison, the current rally has gained about 15% so far. That may seem like a bull market that is gathering steam, but given the historical context, we may not be out of the woods yet.  
  • Bond and currency markets anticipate further rate hikes. While stock investors continue to hope that the Fed will soon reverse its rate-hike program, Fed fund futures imply that the central bank will continue to raise rates for longer. Global currency markets appear to agree, with the U.S. dollar still close to the 20-year high it reached recently.
  • Stocks look expensive. Valuations have re-inflated, with the market’s forward price/earnings ratio now at 18.7. Meanwhile, the equity risk premium—the extra return investors can earn by investing in stocks over risk-free assets—is around 2.6 percentage points. That’s about one whole point lower than the 13-year average. Such valuation concerns wouldn’t be so troubling if it weren’t for the fact that current pricing seems based on unrealistic earnings estimates. While U.S. consumers are still spending and the labor market remains strong, leading economic indicators suggest a slowing in growth that may challenge profit estimates.

Although we can empathize with investor impatience, we caution investors about getting drawn into harm’s way. Inflation is far from tamed, earnings estimates need to be adjusted and stock market enthusiasm just isn’t supported by other market dynamics. Wait for confirming evidence of a new bull market before adding aggressively to portfolio risk.

This article is based on Lisa Shalett’s Global Investment Committee Weekly report from August 22, 2022, “Beware Bear Market Rallies.” Ask your Morgan Stanley Financial Advisor for a copy. Listen to the audiocast based on this report.

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