Morgan Stanley Sees Earnings Risks Weighing on Stocks

(Bloomberg) — Weakening corporate profit forecasts may provide the latest headwind to US stocks, which are likely to fall further before bottoming during the second-quarter earnings season, according to Morgan Stanley strategists.

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“In the absence of an obvious shock like a recession, companies are slow to guide down,” strategists led by Michael Wilson wrote in a note on Monday. “This time should be no different, which means stocks can hang around current levels until the second-quarter earnings season when the next leg lower is likely to begin and end.”

Wilson has been among Wall Street’s most prominent bears and correctly predicted the latest market selloff, which was fueled by worries that a hawkish Federal Reserve would tip the economy into a recession. A strong jobs report on Friday further fanned those concerns and led the S&P 500 to its eighth weekly decline in nine.

Wilson forecasts the US benchmark will trade close to 3,400 by mid-to-late August, implying another 17% downside from its latest close. The largest 5% of S&P 500 stocks still trade at a 40% median premium to pre-pandemic levels compared with 17% for the broader index, he said.

“This potentially presents a downside scenario as well, where these stocks could be the final shoe to drop before we exit the current bear market,” the strategist wrote in the note.

On a sector level in the US, Wilson said food and staples retailing estimates have “collapsed” over the past four weeks. Consumer discretionary and tech hardware have also seen weakness in forecasts, while real estate has seen the strongest positive revisions over the past month, he said.

Margin Squeeze

In Europe, too, risks to corporate earnings are growing, according to Sanford C. Bernstein strategists Sarah McCarthy and Mark Diver, who said Monday that a large margin squeeze may be on the horizon unless soaring consumer demand and sales can persist to counterbalance high inflation.

Still, not everyone is pessimistic. JPMorgan Chase & Co. strategists including Mislav Matejka remain bullish on stocks, saying “the fundamental risk-reward for equities is likely improving as we approach the second half of the year.”