US stocks reached new all-time highs in January before losing over 10% in just 9 trading days. Based on investor sentiment shifts over the past few months, Morgan Stanley says the equity market has probably already peaked for 2018. On the other hand, Fidelity sector strategist Denise Chisholm uses historical probability analysis to show that things often pick up after such a steep and fast correction.
Has the market already peaked for 2018?
Morgan Stanley outlines two reasons it will be difficult for stocks to get back to the record levels in January. “We think January was the top for sentiment, if not prices, for the year,” Mike Wilson, Morgan Stanley’s chief US equity strategist, wrote in a client note. “With volatility moving higher, we think it will be difficult for institutional clients to gross up to or beyond the January peaks.”
The second major risk facing US equity investors, Morgan Stanley says, is retail sentiment that appears to have already peaked. Individual investor bullishness hit a multiyear high earlier this year.
Clues from past corrections
Fidelity sector strategist Denise Chisholm looks for patterns in market history using historical probability analysis. She points out that even though corrections are normal the recent drop was unusually sharp. She looked back at market history and only found 10 other instances where the market fell as fast and sharp since 1960. Chisholm analysis shows that “the market has generally performed well following those sharp corrections, with positive 12-month returns 8 out of 10 times, and an average gain of 17%.”
The sell-off earlier this year was likely the result of investors getting spooked by high valuations paired with rising rates. However, Chisholm says rising rates don’t always mean bad news for stocks.
“I think most investors assume that falling interest rates have been better for the stock market than rising rates. But, in fact, looking back to 1955, the market has had better odds of an advance when rates are rising than when rates are falling. The reason for that seems to be that rates tend to rise when the economy is healthy, and a healthy economy is generally good for the market. So, historically at least, increasing interest rates do not by themselves indicate weakness in the stock market.”
From a historical probability standpoint, there is reason to be optimistic on US stocks following the recent correction. However, from a sentiment standpoint we may have have seen the peak for the year.