'Don't Fight the Fed' is still alive and this week will serve as a reminder - MS

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By Senad Karaahmetovic

Analysts at Morgan Stanley, see the case for the U.S. equities moving lower this week on the back of the month-end rebalancing and the upcoming FOMC meeting.

They seem surprised by the magnitude of the recent jump in stocks; however, the analysts believe all good news is now priced in. The S&P 500 is up just over 6% in January after closing at 4,070.56 on Friday.

“We think the recent price action is more a reflection of the seasonal January effect and short covering after a tough end to December and a brutal year. The reality is that earnings are proving to be even worse than feared based on the data, especially as it relates to margins,” Morgan Stanley analysts wrote in a weekly client note.

Moreover, they argue that “investors seem to have forgotten the cardinal rule of 'Don't Fight the Fed'.”

“Perhaps this week will serve as a reminder,” they added.

The analysts have a $195 forecast for the S&P 500 EPS for this year, which would see the index trade significantly lower from current levels.

“In fact, we are now leaning more toward our bear case of $180 based on the margin degradation so far and what our earnings models are projecting. We think it's important to note that typically when forward earnings growth goes negative, the Fed is actually cutting rates. That's not the case this time around...an additional headwind for equities,” they concluded.

All-in-all, the “1-2” combination of month-end rebalancing and the Fed could facilitate the start of a new leg lower in equities, according to the analysts.