The Stock Market’s Euphoric Rally was a big toy: Wall Street

  • Goldman Sachs, Morgan Stanley, and JPMorgan are warning that stocks are headed for a second wave of pain.
  • The year-to-date rally cannot last, according to Morgan Stanley’s chief US equity strategist.
  • There will be upside as above-trend growth and soft landings have already priced in stocks.

The year began with a euphoric close for the US stock market, but that is about to fade, many Wall Street analysts warn.

The Nasdaq Composite posted double-digit gains at 11% in January, while the Dow Jones Industrial Average and S&P 500 also finished the month ahead. In particular, technology-related bets are driving shares of Tesla and Meta up 82% and 36% year to date, respectively.

Investors are trading on speculation that high inflation was in the rearview and that the Federal Reserve would retreat soon from aggressive rate increases. But according to Friday’s report on Personal Consumption Expenditure, which showed inflation up more than expected in January, the Fed is nowhere near achieving its mission.

As stocks sputter amid renewed inflation worries, leading Wall Street analysts are sounding the alarm this month that the rally of the past six weeks was nothing but a fake.

According to Mike Wilson of Morgan Stanley, traders are behaving like climbers who push blindly towards the summit of Mount Everest without considering the risks involved.

“Many deaths in high-altitude mountaineering have been caused by the death zone, either directly by the loss of vital functions, or indirectly by wrong decisions made under stress or physical impairment leading to accidents,” Wilson wrote.

He added: “This is a perfect analogy for where equity investors are today, and frankly, where they have been many times over the past decade.”

Goldman Sachs chief equity strategist David Kostin has said he is skeptical of market gains so far in 2023. The continued upside in stocks will not last as above-trend growth and soft landings have already priced in US equities .

In fact, Kostin says investors should expect very few gains for stocks through the end of 2023.

“Even if a soft landing materializes, as in our baseline forecast, such an outcome should not lead to a substantial equity market,” Kostin wrote in a client note earlier this month.

Minutes from the Federal Open Market Committee released this week showed openness to continuing to raise interest rates, and a chorus of officials said the fight needed to be kept up.

Morgan Stanley Wealth Management chief investment officer Lisa Shalett recently suggested a pivot from stocks to bonds, citing sharp market valuations as well as a hawkish Fed.

“The problem is that equity and credit markets are fighting the Fed hard, and valuations only support assumptions of substantial rate cuts,” Shalett wrote in a research note earlier this month.

She added: “Rich valuations have little room for error, as the central bank’s guidance for bullish risk-taking counters… Folklore advises not to fight the Fed for a reason.”

Market data also now suggests that the rally is over.

Long-term treasury rates indicate that investors are piling into fixed income assets, according to DataTrek Research on Thursday. Rising bond yields can be chalked up to high inflation expectations, said DataTrek co-founder Nicholas Colas, but there’s also another driver behind the spike in yields.

“This tells us that real interest rates have been rising over the past month, indicating that investors are demanding a higher inflation-adjusted risk-free rate of return,” Colas wrote. “Put another way, the recent spike in yields is not just about inflation. Rather, it is a sign that investors are growing more risk averse.”

Meanwhile, JPMorgan chief stock strategist Marko Kolanovic, a longtime equity bull, says investors should ditch stocks because a recession is coming.

“With common stocks trading near last summer’s highs and at above-average multiples, despite weak earnings and the recent sharp move higher in interest rates, we think markets are overpricing the good news recently on inflation and that they are complacent on risks,” Kolanovic wrote in a. note to clients earlier this month.

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