The stock market's euphoric rally has been a head fake, Wall Street's top strategists warn

  • Goldman Sachs, Morgan Stanley, and JPMorgan are warning that stocks are headed for a second wave of pain.
  • The year-to-date rally can’t last, according to Morgan Stanley’s chief US equity strategist.
  • The upside will fizzle because above-trend growth and a soft landing have already been priced into stocks.

The year kicked off with a euphoric rally for the US stock market, but that’s about to crumble, numerous Wall Street analysts warn. 

The Nasdaq Composite notched double-digit gains at 11% in January, and the Dow Jones Industrial Average and S&P 500 ended the month ahead as well. In particular, tech-related bets have been on a tear with shares of Tesla and Meta up 82% and 36% year-to-date, respectively.

Investors have been trading on speculation that high inflation was in the rearview and that the Federal Reserve would soon back off aggressive rate hikes. But judging by Friday’s Personal Consumption Expenditures report, which showed inflation up more than expected in January, the Fed isn’t close to accomplishing its mission. 

As stocks sputter amid renewed inflation concerns, top analysts on Wall Street have been ringing the alarm this month that the rally of the last six weeks was nothing more than a head fake. 

According to Morgan Stanley’s Mike Wilson, traders are behaving like climbers who blindly push towards the peak of Mount Everest without accounting for the risks involved. 

“Many fatalities in high-altitude mountaineering have been caused by the death zone, either directly through loss of vital functions, or indirectly by wrong decisions made under stress or physical weakening that lead to accidents,” Wilson wrote.

He added: “This is a perfect analogy for where equity investors find themselves today, and quite frankly, where they’ve been many times over the past decade.”

Goldman Sachs’ chief US equity strategist David Kostin has said he is also skeptical of the market’s gains so far in 2023. The continued upside in stocks won’t last because above-trend growth and a soft landing have already been priced into US equities. 

In fact, Kostin says investors should expect very little gains for stocks through the end of 2023.

“Even if a soft landing comes to fruition, as in our baseline forecast, such an outcome should not lead to substantial equity market upside,” Kostin wrote in a client note earlier this month.

Minutes from the Federal Open Market Committee released this week showed an openness to keep raising interest rates, and a chorus of official have spoken of needing to keep up the fight. 

Morgan Stanley Wealth Management’s investment chief Lisa Shalett recently recommended pivoting from stocks to bonds, pointing out the market’s steep valuations as well as a hawkish Fed. 

“Problematically, equity and credit markets are aggressively fighting the Fed, with valuations only supported by assumptions of ample rate cuts,” Shalett wrote in a research note earlier this month.  

She added: “Rich valuations offer little room for error, as bullish risk-taking counters central bank guidance… Folklore suggests not to fight the Fed for a reason.”

Market data now also suggests the rally is winding down. 

Long-term treasury rates signal that investors are piling into fixed-income assets, according to DataTrek Research on Thursday. Rising bond yields can be chalked up to high inflation expectations, DataTrek cofounder Nicholas Colas said, but there’s also another driver behind the spike in yields.

“This tell us that real interest rates have been rising over the last month, indicating that investors are demanding a higher inflation-adjusted risk-free rate of return,” Colas wrote. “Put another way, the recent spike in yields is not just about inflation. Rather, it is a sign that investors are growing more risk averse.”

Meanwhile, JPMorgan’s top stock strategist Marko Kolanovic, a long-time equities bull, says investors should ditch stocks because a recession is coming.

“With equities trading near last summer’s highs and at above-average multiples, despite weakening earnings and the recent sharp move higher in interest rates, we maintain that markets are overpricing recent good news on inflation and are complacent of risks,” Kolanovic wrote in a note to clients earlier this month.