Potential 'False Breakout' Looms For S&P 500 Despite Reaching Bull Market Region, Says Top Wall Street Analyst

The S&P 500 Index may have reached the finish line of the rally that started in October 2022, after breaking above the 4,200 threshold last week. That's the opinion of Morgan Stanley's Equity Strategist Michael Wilson, who sees no evidence of a fresh bull market for the stock market.

The index of the 500 largest-capitalized U.S. equities has risen 21% from its October 2022 lows to its Friday, May 19 high of $4,212, thereby marginally entering the so-called bull market region. According to Wilson, however, both technical signals and fundamental headwinds are in sharp contrast with the idea that this is the start of a new cyclical bull market for the S&P 500 index, which is closely tracked by the SPDR S&P 500 ETF Trust SPY. 

Chart: S&P 500's Price Performance Since October 22's Lows 

Technicals Suggest S&P 500's Rally Might Be A Head Fake Like Last Summer

Wilson thinks that the S&P 500 now has an unfavorable technical setup, as seen by narrow leadership, extremely weak breadth, and considerable underperformance of regional banks, energy/materials, retail, and small companies. 

The rally has not been broad-based among sectors, since "the average stock is down," Wilson said. There is "narrowness in leadership and a flight to quality" behavior, with investors positioning in stocks perceived to be the safest, which are mega-cap tech equities and those associated with artificial intelligence (AI).

The fear of missing out (FOMO) on the next rally triggered panic buying last week, the strategist noted. 

Debt Ceiling and S&P 500's Key Technical Levels To Watch

Wilson does not rule out more marginal gain for the major stock averages if a debt-ceiling agreement is reached. However, that would be viewed as a false breakout or bull trap.

"Passing the debt ceiling may ironically be the catalyst that ends this bear market rally, as it leads to a contraction in liquidity," Wilson said in the note.

The analyst thinks that this would be the "mirror" of the bank events in March, which have then led to an increase in liquidity. "Beware of a false breakout as markets top on good news."

Fundamentals Look Stretched

Fundamentals also support Morgan Stanley's current bearish view of the U.S. stock market. The S&P 500 median stock forward P/E is 18.3x, the S&P 500 ex-tech median P/E is 18.0x and the equity risk premium is less than 200 basis points, all metrics that sit on the expensive camp from a historical point of view. 

The market has factored in mid-to-high single-digit growth in earnings for the second half of the year, in sharp contrast with Morgan Stanley's earnings model, which forecasts 20% downside to 2023 consensus forecasts. 

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