Tech stocks’ blistering rally won’t last and the bear market has ‘unfinished business,’ Morgan Stanley’s top stock strategist says

• Large-cap tech stocks surged in the first quarter, leaving the Nasdaq Composite up 17%.

• But the rally doesn’t translate into the start of a broader bull market, Morgan Stanley said Monday.

• “We see little evidence that a new bull market has begun and believe the bear still has unfinished business.”

The US equity market found strength in a blazing rally in tech stocks in the first three months of 2023, but it still remains vulnerable to making fresh lows and being stuck in  bear-market status for a while, says Morgan Stanley’s top stock strategist.

That prediction follows a defiantly strong first quarter for US stocks, which rallied despite more policy tightening from the Federal Reserve and a surprise banking crisis that arrived on the heels of the the collapse of Silicon Valley Bank on March 10. In particular, tech stocks saw strong gains as investors looked for shelter from the fallout.

“[We] think investors should continue to position portfolios more defensively and focus on companies that exhibit high operational efficiency and high quality of earnings (high cash flow relative to reported earnings and stable accruals),” Michael Wilson, the investment bank’s chief investment officer, said in a Monday research note.

“We see little evidence that a new bull market has begun and believe the bear still has unfinished business.”

Large-cap tech stocks over the past several weeks have been the “clear outlier” in the market from a relative performance standpoint, surging to historical highs, he said.

The Nasdaq Composite finished the first quarter up 17% and has gained about 20% from its most recent low hit in late December.  Also, the S&P 500 Information Technology sector soared 21% in the first three months of this year, making it the best-performing of the S&P 500‘s 11 sectors.

The S&P 500 has advanced about 7.5% this year but was still down by 16% over the past 12 months.

A major factor fueling the surge in tech stocks was investors’ view that the group was a defensive haven following the crisis stemming from the fall of SVB. Hope that the Fed will begin rate cuts this year without a meaningful deceleration in the world’s largest economy also fed the rally in stocks broadly, and growth oriented shares in particular.

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“On the defensiveness point, our work suggests that Tech is actually more pro-cyclical and bottoms coincidently with the broader market in bear markets,” Wilson wrote.

On the liquidity issue, “we don’t view the recently expanded bank funding program [by the Fed] as a form of QE that will ultimately be stimulative for risk assets,” he said. Money continuing to flow into money market accounts combined with an increase in the Treasury General Account because of tax payments may start becoming a headwind for risk-asset liquidity,” he said.

Traditional defensive sectors such as staples, healthcare, and utilities currently hold a better risk-reward profile relative to the tech sector.

“We advise waiting for a durable low in the broader market before adding to Tech more aggressively as the sector typically experiences a period of strong outperformance post trough—a time when its cyclicality works in its favor on the upside,” Wilson wrote.

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