Bear market rally can push S&P to 4,300, but then selloff will resume - Morgan Stanley

May 31, 2022 8:23 AM ETSPDR S&P 500 Trust ETF (SPY)SP500, QQQ, IWM, XLY, XLK, XLCBy: Kim Khan, SA News Editor113 Comments

Bull and Bear Symbol with Stock Market Concept.

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The stock market is in the middle of a relief rally, but the downward trend will resume, Morgan Stanley says.

"Bottom line, our base case remains that last week's strength will prove to be another bear market rally in the end," strategist Mike Wilson wrote in a note. "We see maximum upside near 4250-4300 in S&P 500 (SP500) (NYSEARCA:SPY) terms with Nasdaq (COMP.IND) (QQQ) and small caps (IWM) likely to rally more on a percentage basis as is typical during such rallies - i.e., more heavily shorted areas do the best."

"The turning point for the next leg of the bear may coincide with the next Fed meeting where it will likely be clear they are far from dovish," Wilson said. "This will also coincide with the beginning of 2Q pre-announcement season and the time when companies manage numbers lower before reporting."

"We stand by our call that the S&P 500 will trade close to 3400 by the end of 2Q earnings season - i.e., mid August."

A big driver of the recent run higher has been the Consumer Discretionary (XLY) sector.

"Consumer discretionary stocks are exhibiting a strong tactical rally as shorts scramble to cover what has been one of the best one-way trades of the year," Wilson said. "Not only is the sector the worst performer YTD (-25%) but it's broken a 10 year uptrend relative to the S&P 500. In other words, we were due for a rally in the sector, but at the end of the day, we think it's nothing more than a bear market rally that will eventually fade."

"The other sectors having the most trouble this year are Technology (XLK) and Comm Services (XLC) - i.e., FAAMNG," he added. "Neither has broken down as much as Discretionary but both have also rallied sharply over the past week. Our view remains the same fundamentally speaking: both are vulnerable to a payback in demand and/or a cancellation of orders in the case of tech hardware and semiconductors."

See the Credit Suisse list of stocks that have seen big drawdown, but have improving earnings.

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