I hope you enjoyed the bear market rally. Because it’s over now.
Or at least according to Morgan Stanley’s Mike Wilson it is.
“While Q1 was rough for most stocks, the second half of March was exceptionally strong,” Wilson wrote, in a Monday note. He called the rally “predictable from a technical perspective,” but said it was “always a bear market rally” in Morgan’s view. “Now we think it’s over.”
On Friday, I suggested that if one was comfortable comparing apples to oranges, the ISM apple has now fallen a considerable distance from the equities tree. In the same linked article, I noted the obvious: The inventories gauge moved higher, while new orders plummeted, a potentially inauspicious development.
Wilson underscored both points. The figure on the left (below) shows the new orders gauge now below the inventory component for the first time during the post-pandemic expansion. “This book-to-bill proxy for the broader manufacturing sector suggests meaningful downside to the headline ISM over the next few months,” Wilson warned.
The catch-down implied by the left-hand chart “does not bode well for the S&P,” Wilson said. His annotations (figure on the right, above), suggest the benchmark “should” be at 4,000 today and could sink as low as 3,600 over the next two months.
As regular readers are well apprised, the rally was predicated on flows and positioning. “The equities recovery has been ‘funded’ on three fronts,” Nomura’s Charlie McElligott wrote Monday, describing the bounce as the product of, “i) the liquidation of crowded, short-dated index / ETF option downside hedges as spot rallied [and] vol was hammered into a massive ‘positive delta’ thrust around and out-of March OpEx, ii) the ensuing impulse re-allocation of longs from systematic funds, and iii) the resumption of highly-speculative retail ‘YOLO’ing’ behavior via the options complex.”
Some of that may have run its course, although as McElligott went on to note, the S&P “remains relatively stable from the options dealer hedging flows perspective.” That matters. In fact, there’s a sense in which it’s one of the only things that matters, depending on the circumstances.
For Wilson, though, the situation admits of little ambiguity. “[The] differential between the ISM orders and inventories components leads the headline index,” which in the current conjuncture, “suggests the S&P 500 has another rough month(s) ahead,” he wrote.
The “bottom line,” he went on to say, is that although “the rally in stocks over the past few weeks has been remarkable,” Morgan’s view is that it “had all the characteristics of a bear market rally.” Wilson called month- / quarter-end “the perfect spot” for the rally’s demise.