Want to buy the dip during this bear market? Morgan Stanley says think twice—it’s ‘too early to get bullish’

May 23, 2022, 5:19 PM UTC

In his 1986 Berkshire Hathaway shareholder letter, Warren Buffett wrote that there are occasionally “outbreaks” of two “super-contagious diseases” in markets called fear and greed.

The billionaire investor argued that while it is nearly impossible to time the onslaught of these market epidemics, his goal when investing is simple: “To be fearful when others are greedy and to be greedy only when others are fearful.”

It’s typically wise advice from the so-called Oracle of Omaha, and during the pandemic era, many investors have followed it, repeatedly “buying the dip” whenever stocks fall. The strategy has mostly worked in the “free money era” of extraordinary support for markets from the Federal Reserve.

But Morgan Stanley says you might not want to follow Buffett’s advice at this particular moment. Buying the dip in today’s struggling market could be a recipe for disaster, the investment bank argues—at least for now.

Morgan Stanley strategists led by Michael J. Wilson wrote in a Monday research note that they expect the S&P 500 to fall to 3,400 by the end of the summer, or another roughly 14% from current levels, as earnings growth and consumer spending slow.

“Given the risks to growth are just emerging, it’s too early to get bullish,” the strategists wrote.

The sentiment that stocks have yet to see the end of the pain is widely shared on Wall Street as recession predictions continue to make headlines.

“It is unlikely that we have seen ‘THE’ bottom in stocks until we get some more capitulation,” Bob Doll, CIO at Crossmark Global Investments, an investment management firm that manages $5.5 billion, told Fortune in an email. 

Still, Doll noted that the S&P 500’s forward price-to-earnings ratio—a classic metric used to compare the relative value of companies—fell to just 16x this week. That puts it below the 10-year average of 16.9x and even the 25-year average of 16.3x, which should be a bullish sign for investors.

Morgan Stanley’s strategists said that they expect there will be repeated bear market rallies over the next few months as investors look to buy the dip with valuations nearing historical norms, but that shouldn’t be a buy signal.

The investment bank recommended their clients avoid entering the fray just yet as a cyclical downturn for tech spending is on its way, and earnings will likely disappoint.

“Vicious bear market rallies should be used to lighten up on the areas most vulnerable to the oncoming earnings reset,” they wrote.

A retailer misstep and waning consumer demand?

Last week’s disappointing earnings from major retailers, including Target and Walmart, have sparked fears about the potential for excess inventory to cut into margins, hindering earnings results in the second quarter.

Shares of Target collapsed on Wednesday after the company revealed a 52% year-over-year drop in profits due to rising fuel and labor costs as well as ongoing supply chain challenges.

“We have a lot of work ahead of us to restore profitability to the level where we expect to operate over time,” Target CEO Brian Cornell said on the company’s post-earnings call.

The less-than-stellar results came just a day after Walmart cut its annual profit forecast and saw its shares notch their worst day since 1987.

In Morgan Stanley’s view, these earnings missteps from retailers could be a sign of a demand slowdown for consumers as inflation continues to bite. The investment bank surveyed roughly 2000 U.S. consumers to see what they are planning to spend this year, and the results weren’t exactly bullish.

The survey found that 59% of consumers are planning to cut back on their spending over the next six months. And some 62% of respondents listed inflation as their number one concern for 2022, up from 56% three months ago. That could mean that even if consumers have the money to spend, they might not have the desire.

“While we acknowledge that consumer balance sheets remain healthy, there are two important distinctions to make: first, although consumers have the capacity to spend, we question if they will continue to have the desire to spend, and second, the market is not the economy,” the strategists wrote. “Consumers may still be contributing positively to GDP growth, but they are likely to do so at a lower level. This will weigh on markets where the rate of change is crucial.”

Morgan Stanley stuck with its year-end 3,900 target for the S&P, however, arguing stocks will see a rebound to near current levels after a bearish summer.

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