While investors try to suss out when the longest bull market in history will go into a sustained downturn, Morgan Stanley argues that we may already be in some type of bear market.
As markets closed on Wednesday the S&P 500 was down 5.8% from its record high of 3,025 points set on July 26, which doesn’t come close to the 20% drop that is considered the widely accepted definition of a bear market. But Morgan Stanley believes that “we are still mired in cyclical bear market,” according to a recent report from the investment firm.
Morgan Stanley offers a few different arguments for this cyclical bear market when comparing data from now to January of 2018. First, the S&P 500 has been “roughly flat” with Wednesday’s close being slightly lower than the intraday high on Jan. 26, 2018. Second, 80% of global equity markets have fallen by almost 10%. Lastly, Morgan Stanley points to losses of about 10% for other U.S. stock market indices and most U.S. stocks.
Here is a further breakdown of Morgan Stanley’s findings, per Investopedia:
Significance of the Bear Market For Investors
The report notes that, during the past 18 months, most stock market indices worldwide have fallen significantly from their highs, and have experienced much greater volatility than existed during the prior two years of strong bull market gains.
“Almost 80% of all major indices we track have not made new highs and are more than 10% below those highs,” Morgan Stanley says. “At this point, we would view our call in January 2018 for a multi-year consolidation and cyclical bear market as well established and documented,” they conclude.
Looking at U.S. stocks, the report observes that both the small cap S&P 600 and the mid cap S&P 400 have not reached new highs in 2019, and that both are down by more than 10% from their previous highs set in Sept. 2018.
Additionally, only five of the 11 S&P 500 sectors have set new highs in 2019, and three of those are defensives: utilities, consumer staples and REITs. The other two are information technology and consumer discretionary, the latter’s performance skewed by the inclusion of Amazon.com Inc., which is “more a technological disrupter than a good read on the consumer.”
In 2018, tightening by the Fed created a “rolling bear market” which moved through every major asset class one by one, starting with the “weakest links,” and eventually sending all down for the year, “a rare occurrence in history.” This round of tightening also caused global economic growth to slow, “with the weakest economies getting hit first and hardest.”
While some observers see the recent shift in Federal Reserve policy towards interest rate cuts as a positive for U.S. stocks, Morgan Stanley disagrees. They view this policy reversal as evidence of deteriorating economic fundamentals both in the U.S. and abroad, which are bound to produce further declines in corporate profits and profit margins.
“Perhaps the most convincing evidence for those who question if we are still in the midst of a cyclical bear market is the fact that long-term Treasury bonds have defeated the best equity market in the world over the past 18 months, especially since September,” Morgan Stanley asserts.
Against a deteriorating economic outlook, Morgan Stanley believes that growth stocks are more vulnerable than defensives. As a result, they favor defensives such as utilities and consumer staples, and are underweight in growth sectors such as information technology and consumer discretionary.