Mike Wilson: What is Causing the Market Rally?

As equities enjoy their best week since the summer highs in June, investors seem at the mercy of powerful market trends, so when might these trends take a turn to the downside?

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Welcome to Thoughts on the Market. I'm Mike Wilson, Chief Investment Officer and Chief U.S. Equity Strategist for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the latest trends in the financial marketplace. It's Monday, October 24th, at 11:30 a.m. in New York. So let's get after it.

Last week, we made a tactically bullish call for U.S. equities, and stocks did not disappoint us. The S&P 500 had its best week since June 24th, which was the beginning of the big summer rally. As a reminder, this is a tactical call based almost purely on technicals rather than fundamentals, which remain unsupportive of higher equity prices over the next 3 to 6 months. Furthermore, the price action of the markets has become more technical than normal, and investors are forced to do things they don't want to, both on the upside and the downside. Witness September, which resulted in the worst month for U.S. equities since the COVID lockdowns in March of 2020. The same price action can happen now on the upside, and one needs to respect that in the near term, in our view.

As noted last week, the 200 week moving average is a powerful technical support level for stocks, particularly in the absence of an outright recession, which we don't have yet. While some may argue a recession is inevitable over the next 6 to 12 months, the market will not price it, in our view, until it's definitive. The typical signal required for that can only come from the jobs market. While nonfarm payrolls is a lagging indicator that gets revised later, the equity market tends to be focused on it. More specifically, it usually takes a negative payroll reading for the market to fully price a recession. Today, that number is a positive 265,000, and it's unlikely we get a negative payroll number in the next month or two. Of course, we also appreciate the fact that if one waits for such data to arrive, the opportunity to trade it will be missed. The question is one of timing. In the absence of hard data from either companies cutting guidance significantly for 2023 or unemployment claims spiking, the door is left open for a tactical trade higher before reality sets in.

Finally, as we begin the transition from fire to ice, falling inflation expectations could lead to a period of falling interest rates that may be interpreted by the equity market as bullish, until the reality of what that means for earnings is fully revealed. Given the strong technical support just below current levels, the S&P 500 can continue to rally toward 4000 or 4150 in the absence of capitulation from companies on 2023 earnings guidance. Conversely, should interest rates remain sticky at current levels, all bets are off on how far this equity rally can go beyond current prices. As a result, we stay tactically bullish as we enter the meat of what is likely to be a sloppy earnings season. We just don't have the confidence that there will be enough capitulation on 2023 earnings to take 2023 earnings per share forecasts down in the manner that it takes stocks to new lows. Instead, our base case is, that happens in either December when holiday demand fails to materialize or during fourth quarter earnings season in January and February, when companies are forced to discuss their outlooks for 2023 decisively. In the meantime, enjoy the rally.

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