Investors looking for solace amid the wave of market sell-offs may argue that the S&P 500 has fallen only 9% from its all-time highs in September, hardly a devastating decline. But that statistic conceals the fact that we are already in a deep bear market and more downside is still to come, according to Morgan Stanley’s latest Weekly Warm Up report.

“Not only does the price action this year suggest we are in the midst of a bear market—more than 40% of the stocks in the S&P 500 are down at least 20% — but it also trades like a bear market,” wrote the bank’s analysts. Even companies with good news to report have seen their stocks sell off, a good indicator that the market is in bear territory. Overall, says Morgan Stanley, "The technical damage is irrefutable."

Why Stocks may Fall Further

 Earnings estimates may come down sharply
 Growth stocks face biggest downward revisions
 Major averages S&P 500, Nasdaq and Russell 2000 broke 200-day moving average
 Individual stocks and indexes still face risk

Source: Morgan Stanley

What it Means

As stocks have declined, their valuations have also come down from previously lofty levels. Forward 12-month price-to-earnings ratios (P/E ratios) for the S&P 500 fell as much as 18% from their peak last December to their low at the end of October, which represents about 90% of the valuation damage from the current bear market, according to Morgan Stanley. The rest of the damage will come from declines in stocks with still relatively high price multiples

But while price-multiple valuations may be close to bottoming, that doesn’t mean stock prices are. Earnings estimates are expected to decline and stocks are likely to follow, possibly falling precipitously in 2019. "Obviously the bigger the cuts, the bigger the risk at both the index and stock level," says Morgan Stanley. Since the beginning of October alone, consensus estimates for 2019 earnings per share (EPS) growth are being revised downwards, with the 2019 EPS-growth estimates for the S&P 500 down 1.2%. Among the sectors that have seen the biggest declines in consensus 2019 EPS-growth estimates are Communication Services at -4.2%, Materials at -3.3%, and Consumer Discretionary at -2.3%.

Another highly bearish signal, according to the Morgan Stanley analysts, is that prices for the S&P 500, Nasdaq and Russell 2000 "have definitively broken the 200-day moving average which is now a downtrend.” When that trend-line is broken, it typically takes some time before turning up again, meaning investors need to remain patient and consider selling the rallies instead of buying the dips.

"Historically, when the 200-day moving average turns down it typically takes months, if not longer, to turn up again."—Morgan Stanley

Buying stocks on the dips has failed to deliver in 2018. “A buy-the-dip strategy has not worked this year, the first time since 2002,” says Morgan Stanley. Buying on the dip worked well during the 2008-09 crisis because the Federal Reserve was pumping major stimulus into the financial system in order to keep it alive. But buy on the dip has failed this year because the Fed and other major global central banks have been in more hawkish moods, reversing, or at the very least, tapering that stimulus.

What’s Next

To give Morgan Stanley's bearish outlook more context, it helps to remember that 2018 started off with massive tax cuts that inflated earnings but failed to boost stocks. Now that the positive impact of tax cuts on profits is waning, investors are getting what Morgan Stanley calls a "reality check." That reality is that, as earnings are revised downwards, stocks are sure to fall as well.