(Bloomberg Opinion) — Expensive U.S. stocks are flashing a warning sign that the S&P 500 could fall as much as 26% in the first half of this year, according to Morgan Stanley strategists.
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While recent data suggests the economy could dodge a recession, it has also ruled out the possibility of a Federal Reserve pivot, according to a team led by Michael Wilson. That doesn’t bode well for stocks, as this year’s strong rally has left them more expensive since 2007 according to the measure of equity risk premium, which has entered a level known as the “zone of death,” said the strategist.
The risk-reward ratio for stocks is now “very poor,” especially as the Fed is a long way from ending its monetary tightening, rates remain higher along the curve, and earnings expectations are still between a 10% and 20% too high, Wilson wrote in a note.
“Time to get back to base camp before the next earnings guidance,” said the strategist, who ranked first in last year’s Institutional Investors survey when he correctly predicted the stock sell-off.
After plunging into a bear market last year, US stocks have rallied in 2023 as signs of lower inflation prompted bets that the Fed could slow the pace of rate hikes. However, policymakers warned that interest rates could rise further as price pressures remain elevated, while a gloomy outlook for corporate earnings has dampened risk sentiment in recent days. The S&P 500’s so-called MACD momentum, which shows the relationship between two moving averages of a security’s price, is now weakening, according to data compiled by Bloomberg.
Others on Wall Street have also warned that the rally in stock markets may have gone too far. JPMorgan Chase & Co.’s Mislav Matejka said this week that bets on resilient economic growth and a Fed turnaround are premature, while Bank of America Corp. strategist Michael Hartnett expects the S&P 500 to fall to 3,800 for on March 8, implying falls of approximately 7% from current levels.
Morgan Stanley’s Wilson is much more bearish, saying the benchmark index could fall as low as 3,000, a 26% drop since its last close, in the first half of 2023.
That is “very much out of consensus at the moment,” especially as active retail and institutional investors are more bullish than they have been in more than a year, the strategist said.
(Updates with context on the S&P 500 rally from the fifth paragraph)
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