Bullish signals are flashing! Is a major rebound coming for US stocks? Morgan Stanley "douses cold water": Don't be too optimistic, the rebound's foundation is not solid

According to Zhitong Finance APP, due to concerns about the global trade war, the S&P 500 index has fallen nearly 19% from its peak in February. As the U.S. government begins trade negotiations with partners, the index has recovered about half of its losses. Following the agreement between China and the U.S. to temporarily reduce tariffs on each other's products, S&P 500 index futures surged on Monday, and risk assets rose. In this context, several market breadth indicators suggest that investor confidence in companies of all sizes is increasing. Nevertheless, Morgan Stanley analyst Michael Wilson stated that it is too early to sound the alarm, as the U.S. stock market has not fully emerged from its troubles.

Market Breadth Indicators Send Positive Signals

The equal-weighted S&P 500 index has outperformed the market-cap-weighted S&P 500 index for six consecutive trading days, marking the longest duration since January 2023, indicating an optimistic outlook for the market's ability to drive earnings, the economy, and the U.S. stock market through more companies.

Since Trump suspended the imposition of the most severe tariffs on April 9, every sector of the S&P 500 index has risen, with information technology, industrials, and consumer discretionary sectors leading the way. Strong earnings have supported large tech stocks, while small companies in defensive sectors have become attractive investment targets in an unpredictable macro environment.

Craig Johnson, chief market technician at Piper Sandler & Co., stated, "It's a bit like the foundation of a house—the more stocks that participate in the rally, the stronger the market. Why is breadth important? It tells me how many stocks are running."

An internal indicator that Johnson tracks, which measures market breadth, is about to trigger a buy signal—this indicator is known as the 40-week technical indicator, which tracks the number of stocks trading above their 40-week moving average and 10-week moving average. Additionally, according to Johnson, the cumulative advance-decline line of the S&P 500 index (another market breadth indicator) has reached a new high, a situation that typically occurs before the index rises in the coming weeks and months.

Ned Davis Research's strategists also increased their allocation to stocks last week, after having sold off the stock asset class during last month's market volatility, as some of the company's market breadth data provided positive clues. This includes the ratio of advances to declines over the past 10 days, which triggered the first bullish signal since February 2023.

A team led by the company's chief U.S. strategist Ed Clissold stated in a report to clients, "The concept behind breadth-driven rallies is that the strongest rebounds involve the majority of stocks participating. If some stocks are struggling, many others are still in an uptrend, pushing the average index higher."

Morgan Stanley Sounds the Alarm

Despite this, Morgan Stanley strategists indicate that investor sentiment towards the U.S. stock market is improving, but it is still too early to sound the all-clear. The research team led by Michael Wilson identified four factors necessary for sustaining a more prolonged rally, but they believe only two factors have made progress: "optimism surrounding a trade agreement between the U.S. and China, and robust earnings revisions."

Wilson added, "The other two items on our list—the Federal Reserve becoming more dovish, and U.S. 10-year Treasury yields falling below 4% without recession data—have yet to materialize."

Federal Reserve Chairman Powell reiterated last week the Fed's wait-and-see approach regarding easing monetary policy, while U.S. 10-year Treasury yields are currently above 4.4%. They added, "In our view, U.S. 10-year Treasury yields above 4.5% are detrimental to valuations."

According to Morgan Stanley's analysis, tariffs have been the biggest concern for companies during earnings season, with mentions of tariffs reaching record levels during earnings calls.

Due to tariff uncertainties, about 30 companies have canceled or suspended their earnings guidance, particularly in the automotive, durable goods, and industrial sectors. However, strategists noted that the average gains of these stocks have increased since reporting their earnings.

Meanwhile, Charles Schwab's senior investment strategist Kevin Gordon stated, "Although market participation has improved with the accelerating rebound, it disproportionately favors sectors far removed from the trade war's epicenter." He said, "Consumer-facing, freight, and energy sectors have seen the weakest rebounds, which aligns with the current economic backdrop. I believe the next phase of the rebound needs to include these parts of the market for us to transition from the recovery phase to a sustainable rebound phase."

In Wilson's view, since the S&P 500 has climbed above the previous resistance level of 5500 points, returning to the 5500 - 6100 point range prior to "liberation day," more meaningful gains will depend on the achievement of a U.S.-China trade agreement and a renewed acceleration in earnings revisions.

Morgan Stanley strategists stated, "The next and most important technical test for the S&P 500, since it began its upward trend about a month ago, is at the intersection of the 200-day and 100-day moving averages (5750-5800 points)."