S&P 500 rally is a bull trap; bear market will resume in March - MS

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By Senad Karaahmetovic 

The U.S. stock market valuation remains "broadly expensive," Morgan Stanley's equity strategists warned the broker's clients once again. The S&P 500 closed the week nearly 2.7% lower after falling over 1% on Friday. The index initially printed 5-week lows before racing higher to close at roughly 3970.

Despite a recovery to nearly 4,200 in the S&P 500, the strategists remain of the view that equities are overvalued and a near-term correction is set to extend deeply below 4,000. Their bear thesis is built on expectations that negative earnings trends are set to resume in the coming weeks.

"Falling earnings forecasts are a rarity for such a high quality, diversified index like the S&P 500 and are why bear markets are much more infrequent than bull markets. However, once they start, it's very hard to argue they're over until those NTM EPS forecasts stop falling," the strategists wrote in a client note.

In their last week's regular column, they highlighted that U.S. stocks are more expensive than at any time since 2007 and the Global Financial Crisis. The recent move higher in U.S. stocks will likely prove to be a bull trap, they added.

"We think this rally is a bull trap but recognize if these levels can hold, the equity market may have one last stand before we fully price the earnings downside. We think interest rates and the US dollar both need to fall for this stand to have a chance. Conversely, if rates and the dollar move higher, the technical support should fail quickly," they added.

"Given our view that the earnings recession is far from over, we think March is a high risk month for the next leg lower in stocks," the strategists concluded.