Morgan Stanley

Stocks have staged a major rebound, but investors shouldn’t rush to buy the S&P 500 now. The market may have already come back too far, too fast.

As hard and fast as stocks fell starting in late February, the rebound of the past few weeks has been nearly as stunning. From a low of 2,237 on March 23, the S&P 500, a broad benchmark for large U.S. stocks, had gained 28%, retracing more than half of the original 34% decline.

That doesn’t mean investors should rush back in now, however. Rallies in the middle of bear markets are to be expected. While we still see areas of opportunity (in areas like financials, small caps, cyclicals and health care), a great deal of uncertainty remains.

Below are three key questions. Until investors have answers, markets are likely to remain volatile.

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  • When will the economy reopen? We don’t know and the trade-offs between preserving economic vitality and risking the public health can feel like a prisoner’s dilemma with no good outcome. Morgan Stanley’s biotech research team sees a peak in U.S. cases in mid-May and gradual reopening starting in mid-June, but that is contingent on the availability of widespread testing and monitoring. Clearly, there could be setbacks and delays in this timetable.
  • Will consumers start spending? Roughly two-thirds of the economy is based on consumer spending and recent economic data has been even worse than expected in terms of unemployment, retail sales and consumer sentiment. Even with stimulus checks, extended unemployment benefits and low interest rate loans, it’s unclear whether the majority of consumers will remain cautious about their spending and behavior long after social distancing requirements have been lifted.
  • What will full-year corporate profits look like? Given the first two unknowns, it may be too early to forecast 2020 earnings with accuracy. Morgan Stanley Research estimates there will be a 20% earnings decline and has a year-end price target of 3000 for the S&P 500. That’s only 125 points above where we are now. If the recovery is delayed or reported profits are worse than currently modeled, that price target may not hold.

There are plenty of reasons to be optimistic. Even before the current rally took off, I wrote that it wasn’t too early for investors to return to stocks given the cheap valuations, huge amounts of government stimulus anticipated and likely trajectory of the pandemic.

I’m not suggesting now that you avoid stocks, but rather that you return your portfolio to the appropriate asset allocation for your time horizon and risk tolerance. A Financial Advisor can help you figure that out if you don’t know, but a typical balanced portfolio is made up of 60% stocks and 40% bonds. Even if you didn’t sell stocks in March, you would have to buy them in April just to get back to target allocations.

I continue to recommend dollar-cost averaging, or buying stocks at consistent intervals (say, once a month) regardless of price. That allows you to avoid the risk of putting a lot of money into the market just before a dip while reinvesting when stocks may still be relatively cheap. I also recommend favoring actively managed funds over passive index funds. That way, professional portfolio managers can help identify specific areas of opportunity and avoid potential pitfalls.

Markets have moved very far, very fast given still high levels of uncertainty. Rather than chasing those returns, now is most likely the time to stick with a longer term strategy to rebuild your exposure to risk while using volatility to your advantage.