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Stepan Lavrouk
Stepan Lavrouk
Articles (514) 

Morgan Stanley: Take Profits Now Rather Than Buying the Market

The investment bank argues that we are in a stock market melt-up

May 02, 2019 | About:

As stock indexes approach record highs, many investors may be asking themselves whether they have made a mistake by sitting out this portion of the late-cycle bull market. A recent note from the equity research desk of Morgan Stanley (NYSE:MS) argues they would be better served by taking profits at this point in the cycle, rather than following the recent buying momentum.

Have earnings actually been strong?

We’re now a few weeks into the first-quarter earnings season and we keep hearing from analysts and commentators that the results have been strong. However, I think that a little context is important here. First, consensus S&P 500 earnings estimates for the first quarter have been coming down hard since last September. Back then, forecasts were for 10% year-over-year earnings growth. Between September and March, earnings forecasts fell 14% to a 4% decline.

With earnings season about halfway over, it looks like actual results will come in at somewhere between 0 and -2% growth. Better than expected? Yeah. Strong? Hardly. More importantly, our top-down earnings growth model, which did an excellent job at predicting the earnings slowdown in the first place, is still indicating consensus S&P 500 forward twelve-month earnings estimates are too high by approximately 8%. Meanwhile, the S&P 500 is at all-time highs.”

In other words, although first-quarter earnings have outperformed expectations, those expectations have been continuously revised downward from late 2018. Consequently, the recent outperformance by U.S. equities should be taken with a large pinch of salt. The danger for investors is they may be sucked in by these seemingly good results without consideration for the underlying fundamentals.

Are we in a melt-up?

A melt-up is a large movement in the stock market that arises as a consequence of investors attempting to chase the momentum of a buying wave. Crucially, it is a speculative movement, rather than a result of changes in the strength of the economy. The note goes on to argue that we are already in such a melt-up, and that investors should err on the side of caution:

“Let me be clear: betting on a melt-up is not a sound investment strategy. In our 2019 outlook, we suggested that this year that this year would be much better than 2018, so we remained very overweight global equities until two weeks ago. While the rebound has been much faster than expected, higher prices is not a reason to get incrementally bullish as some may be espousing. That’s why we’re taking profits.

So what will stop the positive momentum in markets? Well, using our old adage that markets actually top on good news, I can’t help but think that the worst-kept secret of a U.S.-China trade deal announcement in the next few weeks might be the event that provides us with the 10% correction you should wait for, rather than try to play a melt-up.”

Buy the rumor, sell the news. That is the big takeaway from this note. Although it may seem counterintuitive, a resolution of the U.S.-China trade dispute may prompt many market participants to cut their positions, leading to an overall correction for equity holders.

Disclosure: The author owns no stocks mentioned.

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About the author:

Stepan Lavrouk
Stepan Lavrouk is a financial writer with a background in equity research and macro trading. Specific investing interests include energy, fundamental geoeconomic analysis and biotechnology. He holds a bachelor of science degree from Trinity College Dublin.

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