Morgan Stanley sees signals of panic buying in S&P 500, ongoing rally 'a head fake'

© Reuters.

Morgan Stanley equity strategists doubled down on their view that U.S. stocks are overvalued.

In a regular weekly column published on Monday, the analysts presented technical and fundamental evidence that underpins their argument the S&P 500 will fail to stage a break of the 2023 range between 3800 and 4200. Even if it does, it will likely prove to be a failed breakout, they wrote.

The S&P 500 set a new 9-month high on Friday when it popped above 4200 before rotating lower to close at 4191.99, down 0.14% down on the day.

“Is this finally the breakout to confirm a new bull market? The short answer is no, in our view, because there are many technical signals that conflict with the idea that this is the beginning of a new cyclical bull market—extreme narrowness (poor breadth), quality/defensive leadership, and broad cyclical underperformance led by the regional banks, small caps, retailers and transport,” the analysts said in a client note.

They reaffirmed their view that valuations are not attractive at current levels and the equity risk premium is less than 200 basis points. They believe that last week’s price action signaled “signs of panic buying.”

“Rather than a short squeeze, the market was driven by the biggest winners as more market participants convinced themselves the next bull market may have begun and they can't afford to miss it.”

However, the analysts argued that this rally will prove to be a head fake like last summer’s.

“We would not be surprised to see further marginal upside for the major averages if a debt ceiling deal is passed. However, we would view that as a false breakout/bull trap. In that event, the short-term upside could take us back toward the August highs at most, in our view, but should then quickly reverse.”