The bear market rally isn't over yet as stocks just survived a crucial test, Morgan Stanley's Mike Wilson says

• Mike Wilson sees a market rally in the short term, but not enough to pivot from his bearish outlook.
• The rally may be driven by declines in yields and the dollar, the Morgan Stanley strategist said.
• An ongoing earnings recession is driving a bear market in the long term, he added.

Stocks may be rallying, but a bear market unwinding is still on the horizon, according to Morgan Stanley stock strategist Mike Wilson. 

In a note published on Monday, the well-known bear said the short-term outlook is positive, though he described the market's recent resilience as running on "borrowed time."

If bond yields and the dollar continue to retreat, then stocks could go higher, with the S&P 500's next resistance level at 4,150, Wilson said, representing 2.5% upside from last week's close.

"Equity markets survived a crucial test of support last week that suggests this bear market rally is not ready to end just yet," he wrote, referring to S&P 500 remaining above its 200-day average. 

The S&P 500 is up nearly 6% since the year's start, and got a boost on Friday, when the yield on the 10-year Treasury fell 16 basis points, while the dollar index dropped by 0.25%.

But those trends are showing some signs of exhaustion, and in the absence of continued declines in yields and the dollar, the bear market rally will fail, Wilson said.

Previously, he has argued that 2023's strong market rally was a "bull trap," that would soon give way to a massive sell-off. 

He remains bearish in the longer term, pointing out that an ongoing earnings recession will continue to affect markets.

Morgan Stanley estimated that the gap between reported earnings and cash flow is the widest in 25 years. If reported earnings outpace cash flow, then profits may be unsustainable. That may be the case, Wilson said, as excess inventory and capitalized costs have yet to appear in the bottom line.

"There is plenty of bullish and bearish fodder in these charts and one will have to take their own view on the fundamentals," he wrote. "Our view remains the same — the bear market is not over — but we acknowledge that Friday's price action may extend it a few more weeks. Time will tell."