One of Wall Street’s most prominent bears sees the current rally in US stocks extending -- prior to the selloff recommencing.

Morgan Stanley strategists led by Michael Wilson say the S&P 500 Index may climb another 5 per cent to 7 per cent, before resuming losses.

“We think US equity markets can rally further,” they wrote in a note, with a decline in both bond yields and oil prices having eased some worries around runaway inflation and helping the benchmark snap a three-week losing streak.

US stocks have been roiled this year by concerns that a combination of a hawkish Federal Reserve and surging inflation could tip the economy into a recession. The S&P 500 is in a bear market after falling 20 per cent from its January peak and is on course for its worst first half since 1970. S&P 500 futures were up 0.3 per cent while Nasdaq 100 contracts gained 0.4 per cent as of 6:23 a.m. in New York on Monday. 

Wilson, who correctly predicted this year’s selloff, said a retracement of 38 per cent to 50 per cent of the entire decline “would not be unnatural or out of line with prior bear market rallies.” That would lift the S&P 500 to as much as 4,200 points, giving the index about 5 per cent to 7 per cent upside from Friday’s close, with interest-rate sensitive stocks driving the rebound, he said.

Jefferies LLC strategist Sean Darby, meanwhile, said that the combination of depressed investor sentiment, extreme short positioning and rising cash levels were leading to a “vicious” short squeeze. “Investors are standing between a rock and a hard place -- sentiment is abysmal just as full blown capitulation begins but the sell side has not necessarily cut earnings estimates,” the Jefferies team wrote in a note on Monday.

Morgan Stanley’s Wilson also warned that with fears of an economic slowdown driving the drop in oil and yields rather than a peak in inflation, stock markets are ultimately in for more declines.

“The bear market is likely not over although it may feel like it over the next few weeks as markets take the lower rates as a sign the Fed can orchestrate a soft landing and prevent a meaningful revision to earnings forecasts,” the strategist said.

In his base case, which calls for a soft economic landing, Wilson sees the S&P 500 bottoming between 3,400 and 3,500 index points -- as much as 13 per cent below its latest close. A recession would send the index more than 23 per cent lower to about 3,000, he said.