Selloff in Stocks Isn’t Over Yet, Says Morgan Stanley

(Bloomberg) — The rout in stocks isn’t over just yet, according to Morgan Stanley strategists, who see scope for both US and European equities to correct further amid mounting concerns of slowing growth.

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Strategist Michael Wilson, who has long been a skeptic of the decade-long bull run in US stocks, said in a note that even after five weeks of declines, the S&P 500 is still mispriced for the current environment of the Federal Reserve tightening policy into slowing growth.

According to his base scenario of “fire and ice,” he expects the S&P 500 to slide in the near term before climbing to 3,900 points next spring — which is still about 2.5% below current levels — on slowing earnings growth and elevated volatility.

“We continue to believe that the US equity market is not priced for this slowdown in growth from current levels,” Wilson said in a note on Tuesday. “We expect equity volatility to remain elevated over the next 12 months.” He recommends defensive positioning with an overweight in health care, utilities and real estate stocks.

The call from one of Wall Street’s most vocal bears is in sharp contrast to some strategists including Peter Oppenheimer at Goldman Sachs Group Inc., who said on Tuesday that the powerful selloff in stocks in the past weeks had created buying opportunities, with headwinds such as inflation and hawkish central banks already priced in.

After capping their longest streak of weekly losses since 2011 last week, US equities bounced slightly on Tuesday. However, the recovery didn’t last and futures erased gains and tumbled on Wednesday after data showed US consumer prices rose more than forecast in April.

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Berenberg strategists also took a cautious tone, saying that although it’s “tempting” to buy the dip, US stocks continue to look expensive amid margin pressures.

The S&P 500 may be at risk of further downside toward 3,600 points — down 10% from the Tuesday close — before reaching a historically important technical support level. The 200-week moving average since 1986 has seen the US benchmark bounce back during all major bear markets, except for the tech bubble and the global financial crisis.

Over in Europe, Morgan Stanley’s Graham Secker is staying cautious on the region’s equities and expects them to drop further given the challenging economic situation, the war in Ukraine and the risk of earnings downgrades in the second half of the year from falling margins.

“Let’s keep it simple – the macro backdrop is very difficult for stocks,” Secker said in a note on Wednesday, adding that a reduction in Russian gas imports was the biggest bear case risk. “Although investor sentiment is low and equity valuations are reasonable, the difficult fundamental outlook is likely to drive stocks lower over the coming months.”

Secker cut his rating on European mining and construction and materials stocks to neutral and said it was “too soon” to add cyclical exposure back into portfolios, while lifting food, beverage and tobacco shares to neutral. Morgan Stanley strategists are overweight the FTSE 100 and prefer defensives over cyclicals, staying overweight value shares versus growth with a defensive tilt.

Strategists at Barclays Plc also said market action in Europe is turning more defensive on slowing growth and more hawkish monetary policy.

(Updates with today’s US CPI data in sixth paragraph)