Jitters linger despite the relative calm in markets

As share benchmarks touch ‘correction territory’ at the start of a normally bullish time of year, many will be inclined to buy, but Morgan Stanley’s Mike Wilson remains bearish.

Risk aversion and safe haven demand in global financial markets didn’t increase in response to the weekend news that Israel’s long-awaited ground invasion of Gaza had begun.

Instead there was a slight improvement in risk assets and a bit less demand for safe havens.

There may now be scope for a rebound in shares although Morgan Stanley remains bearish.

S&P 500 futures rose 0.4 per cent in Asia-Pacific trading after the US benchmark hit a six-month low on Friday, entering a “correction” after falling 10.3 per cent from its July 31 peak.

Australia’s S&P/ASX 200 share index also entered a correction, having fallen 10.4 per cent from its February 3 peak. It hit a 12-month low of 6751.3 in reaction to Friday’s falls in European and US sharemarkets, before closing down 0.8 per cent at 6772.9 on Monday.

Brent crude oil futures fell 1 per cent to $US88.34 a barrel, spot gold fell 0.4 per cent to $US1975 per ounce and the US 10-year bond yield rose three basis points to 4.88 per cent.

In the weeks since Hamas launched a series of co-ordinated attacks on Israel on October 7, there has been a pattern of less risk aversion at the start of the week and more concern before the weekend, so Monday’s relative calm could be just more of the same.

But as the S&P 500 and S&P/ASX 200 touch “correction territory” at the start of what is typically the most bullish time of the year, many investors will be inclined to buy simply because that threshold has been met. That could lead to a test of resistance at the former support levels at 4200 and 6900.

The calm initial reaction by global markets to the weekend events in Gaza, coming after significant corrections caused by various factors including soaring bond yields, will lead many to do as Warren Buffett said: “Be fearful when others are greedy, and greedy when others are fearful.”

BofA’s Global Fund Manager Survey this month found that sentiment turned bearish.

The average cash level rising to 5.3 per cent pushed BofA’s trading rules close to a buy signal.

Still, BofA’s expected “hard floor” for the S&P 500 at 4200 points based on their fund manager survey was convincingly broken last week.

At the same time, Morgan Stanley continues to warn that the US sharemarket is likely to keep falling regardless of Middle East developments.

Morgan Stanley’s US equity strategist Michael Wilson is sticking to his view that the chances of the usual December quarter rally in US shares have “fallen considerably” in the past month and that the S&P 500 will end the year around 3900 – about 5 per cent lower.

His observations on narrowing breadth, cautious factor leadership, falling earnings revisions and fading consumer and business confidence tell a different story than the consensus, which sees a rally into the year end that’s based mostly on bearish sentiment and seasonal tendencies.

While acknowledging that sharemarket sentiment deteriorated in September, Mr Wilson says sentiment recovered this month on the expectation of better September quarter earnings and seasonal strength into the year end.

In his view, the fundamental set-up is “different than normal this year”, with earnings expectations too high for the fourth quarter and 2024, even in an economy that’s performing well.

“Monetary and fiscal policy are unlikely to provide relief and could tighten further,” he warns.

“More specifically, as our economists believe, while the Federal Reserve may be done hiking for now, it is a long way from easing.

“Furthermore, Fed tightening over the past 18 months is just now starting to be felt across the economy.”

He says the stockmarket has taken notice, with some of the more economic and interest rate-sensitive sectors like autos, banks, transport, semiconductors, real estate and consumer durables underperforming significantly over the past three months.

More recently, many defensive sectors and stocks have started to outperform, together with energy, which supports his “late cycle” view and his preference for a “barbell” of defensive growth stocks and “late-cycle cyclicals”.

He thinks this performance backdrop reflects a market that is “incrementally more concerned about growth than higher interest rates and valuation”.

Even though the Fed has tightened monetary policy at the fastest pace in 40 years, it is still confronted with sticky labour and inflation data that have been obstacles to signalling a definitive end to the tightening cycle or when it will begin to ease policy.

At the same time, the fiscal deficit has expanded to levels rarely seen with full employment.

“These constraints are exactly why the Fed has indicated a ‘higher for longer’ stance,” Mr Wilson says.

In his view, the strength in the headline labour data masks the headwinds faced by the average company and household that the Fed can’t address proactively, which is one reason why market breadth continues to exhibit notable weakness.

“While some may interpret this as a bullish signal – oversold conditions – we believe it’s more a reflection of our view that we are still against a late-cycle backdrop where earnings remain at risk for most companies,” Mr Wilsons says.

In another sign that this negative revision breadth is an early warning sign for corporate earnings, US stocks are trading poorly after earnings reports this month whether they are good or bad.

Mr Wilson remains comfortable with his longstanding 3900 year-end target for the S&P 500, which implies a 17 times multiple on his 2024 earnings per share forecast of about $US230.