Stock bear market is ‘incomplete’, Morgan Stanley’s Mike Wilson warns

“The risk/reward ratio is not attractive, and this bear market remains incomplete.”


— — Michael Wilson, Chief US Equity Strategist and CIO, Morgan Stanley

Morgan Stanley’s Michael Wilson, one of Wall Street’s most vocal bears who correctly predicted this year’s stock market selloff, warned that the bear market was not complete as disappointing earnings revisions to the over the next few months could drive stocks down.

U.S. stocks continued their rally from their mid-June lows, with the Nasdaq Composite COMP,
+0.65%
break out of bear market territory last week, while the Dow Jones Industrial Average DJIA,
+0.48%
and S&P 500 SPX,
+0.43%
also saw further upward momentum.

Wilson attributed the recent rally to a combination of better-than-expected second-quarter earnings, light positioning and continued hope for a less hawkish Fed trajectory. Inflation reports last week encouraged investors to retreat to equities, believing that easing inflationary pressures could allow the Fed to raise interest rates less aggressively. However, “the macro, political and earnings setup is much less favorable for equities today,” according to Wilson.

“We believe the catalyst will eventually center on earnings disappointment,” Morgan Stanley strategists led by Wilson, the bank’s chief investment officer, wrote in a client note on Monday. “While Q2 earnings may seem like a win to some, the reason we saw relief is that expectations fell significantly in the quarter, a dynamic the stock market discounted ahead of the season. reports.”

According to Wilson, earnings revisions are deep in negative territory and begin their final decline well before earnings season. He thinks a similar dynamic should play out ahead of the third-quarter earnings season starting in September. The chart below shows seasonal earnings revisions deteriorating noticeably over the next two months, and this year’s revisions have also tracked the historical trend closely.

SOURCE: FACTSET, MORGAN STANLEY RESEARCH

“While many have focused on the impact of recent jobs and CPI prints from a Fed policy perspective, we also came away with some fundamental takeaways,” Wilson said. “The combination of sustained and higher labor costs and a slowdown in end-market/consumer prices strongly signals margin pressure, which is at odds with optimistic consensus estimates.”

Morgan Stanley’s predictions are in line with some other Wall Street strategists. The BlackRock Investment Institute said in a note on Monday that it expects U.S. corporate earnings to deteriorate and the Federal Reserve to raise interest rates to a level that “will stall the economic recovery.” They also called the stock market’s summer rally unsustainable.

However, JPMorgan strategists led by Mislav Matejka, the head of European and global equity strategy, wrote that the rebound could still last until the end of the year, driven by a steepening yield curve instead of the magnitude of the Fed’s next rate hike. JPMorgan strategists have remained among the very few bullish voices on Wall Street despite extreme turbulence in financial markets this year.

See: Ready to cash in on this stock market race? This strategist says a way out is about to emerge.

Stock futures rose slightly on Monday afternoon, reversing price from the open after investors digested disappointing data on New York’s manufacturing activity and the Chinese economy. The S&P 500 gained 17 points, or 0.4%, to trade near the 4,300 level on Monday afternoon, while the Dow Jones Industrial Average rose 170 points, or 0.5%, to 33 930. The Nasdaq Composite gained 71 points, or 0.5%. at 13,118.

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