Investors chasing the US equity rally should pull back as the S&P 500 Index bumps up against key technical levels on charts and the earnings season will probably bring more bad news, warned Mike Wilson, Morgan Stanley’s chief US equity strategist.
That double hurdle is likely to send the S&P 500 back to its December lows at around 2,350, Wilson said in a research note.
It faces challenges around the range of 2,600 to 2,650, “which is a good level to start lightening up,” he said.
The benchmark gauge came within five points of 2,600 for a third day in a row through last week.
“The issues we still need to deal with include the fact that we are in the midst of a fairly steep and broad negative earnings revision cycle, and there is significant technical resistance-overhead not far above current prices,” Wilson wrote in a note to clients.
“We expect upcoming negative data will prove 2,600 to 2,650 to be a good sale before a proper retest of the December lows,” he said.
US stocks weakened as China trade data showed a worse-than-expected slump and Citigroup kicked off the fourth-quarter reporting season with lacklustre results.
While Wilson has predicted a 50% probability of S&P 500 earnings suffering two-quarters of declines this year, he said the fourth-quarter rout that sent stocks to the brink of a bear market largely reflected the expected recession.
Once the market revisits its December lows on less momentum and better breadth, investors should consider buying cyclical stocks that were hit the hardest during the recent slump, such as energy shares, according to Wilson.
“We are likely to experience a rolling bottom as a prelude to the next bull market on a first-in, first-out basis. That means early cycle stocks and regions that tend to do well once a recession is priced,” he wrote.
“Wait for the retest and look to buy the cyclicals,” he said.
A recent rally in stocks, fuelled by US-China trade optimism and hopes of a slow pace of interest rate rises, has driven a 10% gain in the S&P 500 from its Christmas Eve low.
The benchmark index is about 12% away from its September 20 record close.
“Obviously the biggest concern is the China trade data and people are seeing it in terms of a global synchronised slowdown that is potentially picking up,” said Yousef Abbasi, global market strategist at Intl FCStone in New York.