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The rally will end in a week or two, Morgan Stanley says

Morgan Stanley

An incredible rally last week in the great junk race as bond yields fell. Shares of mostly money-losing tech companies ARK Innovation ETF ARKK rose 19% last week, while shares of regional banks SPDR S&P Regional Banking ETF KRE rose 12%.

Also showing strong growth was a group of so-called lottery stocks, although they included WeWork (WE), which could go to zero, which is why they are called lottery stocks.

“We believe the rally in stocks over the past week was largely the result of falling Treasury yields,” Wilson says. And that drop, he said, was driven more by lower-than-expected coupon issuance and weaker economic data than anything Jerome Powell said. Continuing claims are now up more than 35% from the cycle low, and the unemployment rate is up 0.5% from lows that have been important thresholds in past cycles.

Wilson notes that the earnings revision range remains in negative territory. “Earnings declines continue to show this year, particularly at the stock level. This is one of the key reasons why the broader indexes and S&P 500 stock averages have been weaker this year,” he says. And weak economic data only strengthens the bank's view that the downturn in profits is not over yet.

So what's happening now? For asset owners and their allocations, the prospect of adding additional risk at current levels is less attractive than fixed income alternatives. “We think this group is more likely to sell at this stage,” he says.
Overall, Wilson said, the rally should "wind down over the next week or two" as it becomes clear that the growth picture does not support either a Fed rate cut or a significant acceleration in earnings per share growth.

Supporting the Fed's view: Barclays continues to call for another Fed rate hike in January rather than December.


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