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The stock market's 'dead cat bounce' is over and the rolling bear market is making a comeback, Morgan Stanley says

Jonathan Garber
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  • The stock market may have bounced back from its sharp sell-off at the beginning of October, but Morgan Stanley says the selling will pick back up soon.
  • The firm expects the S&P 500 to slide back below the 200-day moving average, a key technical level.
  • Tread carefully in tech and consumer discretionary, Morgan Stanley warns.

The stock market may have bounced back from its sharp drop at the beginning of October, but Morgan Stanley says it's time to buckle up because the "rolling bear market has unfinished business with the S&P."

"We think attempts to rebound were more short lived than sustainable," a Morgan Stanley team led by the equity strategist Michael Wilson said in a note sent out to clients on Monday.

"Recent price declines in crowded Growth, Tech, and Discretionary have caused enough portfolio pain that we think most investors are playing with weak hands. We are increasingly thinking a rally into year end will be harder to come by as lower liquidity and concerns on peaking growth weigh on the S&P and an investor base in defense mode."

The Morgan Stanley team hypothesized earlier this year that a bear market in stocks might have already begun and that earnings growth would deteriorate in the second half of the year as the impact of President Donald Trump's tax cuts began to fade.

Wilson and his team say they are looking for the S&P 500's 200-day moving average — which has been tested a handful of times this year, but has held — to finally give way.

Simply put, the 200-day is an indicator traders use to determine the overall trend of the market. The market is in an uptrend as long as it's above its 200-day, and it's in a downtrend if it's below the measure.

So what can that mean for stocks? The benchmark index suffered through a correction, or worse, the past two times it fell below the key technical level.

In August 2015, the S&P 500 plunged 15% amid the fallout from Greece's default on a loan payment and China's "Black Monday," the day the country's benchmark Shanghai Composite index fell more than 8%. Before that, the S&P 500 plunged into a brief bear market after the US lost its AAA rating at the ratings agency Standard & Poor's. In both instances, the S&P 500 wouldn't make new highs for at least five months.

If there is any comfort for investors, it's that the firm said earlier this year that it didn't think the 20% to 40% stock-market plunge that characterized the past three bear markets would rear its head this time. Instead, it sees individual stocks and sectors coming under fire. Wilson's team says to tread carefully in two sectors: tech and consumer discretionary.

"Given the high degree of cyclicality in both Tech and Consumer Discretionary, we think their derating should be more in line with the broader S&P 500, or another 6-8 percent," they wrote.

"Of course, that begs the question of whether the valuation for the S&P 500 has fallen too far already. We don't think so."

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