January’s record highs may have been the market top for 2018, Morgan Stanley says

  • "With volatility moving higher we think it will be difficult for institutional clients to gross up to or beyond the January peaks," notes Mike Wilson of Morgan Stanley.
  • "Retail sentiment indicators also look to have peaked in January and we do not see anything on the horizon to get retail investors more bullish than they were following a tax cut," Wilson says.
  • The Dow Jones industrial average and S&P 500 both hit record highs on Jan. 26 before briefly dipping into correction territory in February.

Stocks could struggle for the rest of the year to break above January's record levels as volatility picks up and sentiment dwindles, according to a top strategist from Morgan Stanley.

"With volatility moving higher we think it will be difficult for institutional clients to gross up to or beyond the January peaks," Mike Wilson, the bank's chief U.S. equity strategist, wrote in a note Monday. "Retail sentiment indicators also look to have peaked in January and we do not see anything on the horizon to get retail investors more bullish than they were following a tax cut."

The Dow Jones industrial average and S&P 500 both hit record highs on Jan. 26 before briefly dipping into correction territory in February. Both indexes were at least 5 percent removed from those levels as of Monday.

"Back in January when stocks were rising sharply, we heard numerous calls for a 'melt-up' being made by prognosticators and investors," said Wilson. "Of course, that's how tops are made and we think January marked the top for sentiment, if not prices, for the year."

"When we look at our internal data combined with industry flows and sentiment, we think there is a strong case that January was the melt-up, or at least the culmination of it," he added.

Prior to the correction in February, the major indexes had been on a tear amid an unprecedented period of subdued volatility. The Cboe Volatility index (VIX) — widely considered the best gauge of fear in the market — hit 8.56 last year, a record low. But volatility reawakened last month on worries of rising inflation. The VIX hit a high of 50.30 in February before trading around 20 on Monday.

The indexes also got a lift earlier in the year after President Donald Trump signed a bill that slashed the corporate tax rate to 21 percent from 35 percent. The cuts helped boost investor sentiment.

"Tax cuts were the event to capture investors' imagination, but the reality is that the market had been pricing tax legislation in for months, if not quarters," Wilson said.