Banking sector likely to lead to vicious start to the bear market

According to Morgan Stanley, Turmoil within the banking sector is likely to lead to a vicious start to the bear market in the U.S.

Michael Wilson, the chief U.S. equity strategist at Morgan Stanley and a longtime Wall Street bear, said in an analyst note on Monday that the bear market is in the early and painful stages of exiting the bear market than in the summer.

The last part of the bear can be vicious and highly correlated, he said. Equity risk premium spike that is very hard to prevent or defend in one's portfolio makes prices fall sharply. He suggested that stocks are not worth the risk when investors can turn to safer assets like Treasurys and other bonds. The S&P 500 will remain unattractive until the equity risk premium that measures the expected return on stocks above the risk-free rate climbs as high as 250 basis points. The ERP is currently at 230 basis points.

Wilson said that the real buying opportunity comes with it because we have been waiting patiently for this acknowledgment. The risk reward in U.S. equities remains unattractive because of the risk to the earnings outlook, we think it is unattractive until the ERP is at least 350 -- 400 bp. Stocks closed on Friday, with big declines at mid-sized regional banks despite an unprecedented effort to rescue First Republic Bank. The S&P 500 and Nasdaq Composite increased for the week despite the losses.

Wilson believes that the gains stemmed from Wall Street's misplaced optimism that the Federal ReserveFederal Reserve was rekindling a policy initiative similar to quantitative easing.

He said that the Fed FDIC bailout of depositors is a form of quantitative easing QE and provides the catalyst for stocks to go higher.

He continued, while the huge increase in Federal Reserves last week did restructure the banking system, it does little in terms of creating new money that can flow into the economy or markets, at least beyond a brief period, he said.

One week ago, the Treasury Department, Federal Reserve and the FDIC announced that the federal government would protect all deposits at the failed Silicon Valley Bank, even those holding funds that exceeded the FDIC's mandate.

The Fed is lending, not buying, unlike typical quantitative easing.

If a bank borrows from the Fed, it is expanding its balance sheet, making leverage ratios more binding, he said. When the Fed buys the security, the seller of that security has balance sheet space available for expansion. That is not the case in this situation.