Morgan Stanley Strategist Sees Risks to Stocks From Earnings, Fed

(Bloomberg) — A rally in US stocks leading up to this earnings season presents a near-term risk to equities given the prospect of further Federal Reserve rate hikes and fading profit growth, according to Morgan Stanley’s Michael Wilson.

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The S&P 500 rallied more than 6% in the final three weeks of March, in contrast to selloffs in the lead-up to the previous three reporting seasons, and that’s a cause for concern to Wilson — one of the most bearish voices on Wall Street.

“We think this dynamic poses a near-term risk for stock prices given our more pessimistic outlook for earnings this year, especially as the liquidity picture becomes less accommodative,” Wilson wrote in a note on Monday.

The strategist — who ranked No. 1 in last year’s Institutional Investor survey after he correctly predicted the selloff in stocks — doesn’t expect a trough in earnings growth until the third or fourth quarter of the year, a contrast with consensus analyst estimates for a rebound in the second half.

“Net-net, the data suggest to us that the business cycle is continuing to slow and that consensus EPS expectations for 2023 remain materially too high,” he wrote.

March’s rally in the S&P 500 was fueled by increased liquidity from authorities to relieve the regional banking crisis, although Wilson feels that’s likely to change.

While the containment of banking stress is a clear positive, it may mean that policy expectations for 2023 become less accommodative on both liquidity and interest rates, he said.

“Historically, when forward EPS growth goes negative as it is today, the Fed is cutting rates, not hiking,” Wilson wrote. “However, the Fed has been hamstrung by inflation, making this cycle a historical anomaly in this respect — ultimately a near-term headwind for equities, in our view, until an easing cycle begins.”