Latest Market Rally ‘Bear Market Trap,’ S&P 500 Predicted to Decline 25 Percent: Morgan Stanley Strategist

The logo for Morgan Stanley on the trading floor at the New York Stock Exchange in New York City, on Aug. 3, 2021. (Andrew Kelly/Reuters)

Michael Wilson, Morgan Stanley’s chief U.S. equity strategist, is warning investors not to get caught in the “bear market trap” after seeing the stock market rally during the initial weeks of 2023, and estimated that the market might make a low by spring.

According to Wilson, 2023 is off to a “much better start” compared to last year. This was partly driven by a bearish view from investors. Three weeks into the new ear, the bearish view “has changed almost 180 degrees,” he said during the podcast “Thoughts on the Market” on Jan. 30.

Most investors have now adopted a positive narrative of the market owing to factors like falling inflation, China reopening, declining dollar, and the Federal Reserve potentially pausing interest rate hikes. Wilson notes that this new narrative which is becoming popular has already been priced in by the market.

“What’s happening now is just another bear market trap, in our view, as investors have been forced once again to abandon their fundamental discipline in fear of falling behind or missing out,” he said.

“This FOMO (fear of missing out) has only been exacerbated by our observation that most missed the rally from October to begin with, and with the new year beginning, they can’t afford to not be on the train if it’s truly left the station.”

Lows by Spring

Even though 2023 is off to a good start for stocks, Wilson thinks that this is “simply the next and hopefully the last bear market rally.”

The investment expert expects the final lows to be made by spring when the Fed tightening that began last year gets “more accurately reflected” in both stock valuations as well as growth outlooks.

The S&P 500 Index is up more than 5 percent this year, as of Jan. 30. Wilson had previously suggested that the index could crash to 3,000 points by the end of this year. Given that the benchmark is currently trading at around 4,017, this would mean a decline of around 25 percent.

Goldman Sachs is also predicting bad news for the stock market. Analysts at the firm recently estimated S&P 500 to crash by up to 22 percent by spring if the American economy slips into a recession.

Even if the U.S. economy manages to avoid a recession, Goldman Sachs still expects a 10 percent decline in the S&P 500, with the index ending 2023 roughly flat.

In a November 2022 report, strategists with the bank predicted the stock market decline to intensify ahead of hopeful signals emerging later in 2023. Before equities see a sustained rally, the deterioration in economic growth has to stabilize and interest rates have to peak, the strategists stated.

50 Percent Decline, Recession

In his 2023 outlook letter published on Jan. 24, Jeremy Grantham, chief investment strategist at Boston-based Grantham, Mayo, & Otterloo (GMO), predicted a 20 percent decline in the S&P 500 by the end of the year. But if things go wrong with the economy, the index could even halve.

“Even the direst case of a 50 percent decline from here would leave us at just under 2,000 on the S&P, or about 37 percent cheap,” he warned.

“To put this in perspective, it would still be a far smaller percent deviation from trendline value than the overpricing we had at the end of 2021 of over 70 percent. So you shouldn’t be tempted to think it absolutely cannot happen.”

The foreboding predictions for the stock market come amid heightened expectations of a recession. In December, the Conference Board Leading Economic Index (LEI) for the United States declined for the tenth straight month, signaling a recession.