Morgan Stanley's Shalett advises investors to beware this bear market rally

Published Fri, Feb 3 20232:20 PM ESTUpdated Fri, Feb 3 20234:37 PM EST

Investors should be happy with the gains they reaped from a January stock market rally that wasn't justified by fundamentals, according to Lisa Shalett, chief investment officer, wealth management at Morgan Stanley. "The market is extraordinarily overbought," Shalett said in a phone interview. "We know we broke through some positive technicals. We think a lot of that is being driven by liquidity. But we think folks buying in here are buying into yet another bear market rally. This feels so much like January of 2000, where everyone said the worst is behind us and it was only the beginning." The S & P 500 popped more than 6% for the month after a brutal 2022 that saw a nearly 20% loss. Those early-year gains came was investors grew hopeful that the Federal Reserve was nearing the end of an aggressive rate-hiking cycle that boosted the borrowing rate by 4.25 percentage points. Though the central bank hiked again on Wednesday , markets again took solace from Fed Chair Jerome Powell who seemed to vacillate on how far policymakers would push their inflation fight. Shalett thinks over-optimism about an accommodative Fed is a mistake. She sees a central bank able — thanks to reasonably strong economic growth — to keep rates elevated after being forced to hold them artificially low to support a fragile economy. In turn, that will make the S & P 500's valuation near 19 times earnings hard to support because of deteriorating corporate fundamentals. Low rates, in contrast, were supportive of higher valuations. "So the market assumes that's where were going back to. We're not, and that's going to be a shocker," Shalett said. "That is what's going to make the next three to five years feel an awful lot like the beginning of the 2000s, when growth stocks and technology stocks couldn't get out of their own way because valuations had to deflate." Shalett isn't recommending investors get completely out of the market. Morgan Stanley, in fact, thinks sectors such as energy and financials, as well as select industrials, will benefit in the current climate. But the firm also sees great opportunities in shorter-duration bonds as an income provider while the equity market gyrates. "We're telling our clients to lighten up on stocks, take profits here," she said. "Move into fixed income, shorten your duration, earn your 4.5%, close your eyes, step back and look where we are in September, October, November. You just made your full-year gains in the first month. Don't be greedy."