Stock indexes are at new lows this year, says Morgan Stanley’s Wilson

(Bloomberg) — Investors should brace for more pain as U.S. stock indexes have yet to bottom out for the year, according to Mike Wilson, chief U.S. equity strategist at Morgan Stanley.

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“The index is usually the last thing to go down,” Wilson, who predicted this year’s selloff in stocks, told Bloomberg Markets on Wednesday, referring to the S&P 500. “June was probably the low for the average stock, but the index, we think, we still have to get out of those June lows.”

The U.S. benchmark rose as much as 17 percent from its mid-June low of 3,666.77, after plunging more than 20 percent in the first half. The S&P 500 then retreated from mid-August amid concerns that the Federal Reserve’s aggressive monetary tightening could tip the economy into recession.

“We see 3,400 for the growth slowdown or soft landing scenario,” Wilson noted.

That would mean a 15% slide for the S&P 500 from Tuesday’s close. A “proper recession” would bring the index somewhere near 3,000. And while it’s hard to predict the bottom of the market, the bank’s chief U.S. equity strategist said “the direction is bearish at least for the next quarter or two.”

U.S. stocks struggled to find solid footing on the final day of August, a month that saw everything from bonds to commodities slide as central banks stepped up efforts to stave off blistering inflation. Investors anxiously awaited Friday’s jobs report, which will provide more clues about the pace of Fed hikes.

Read: Powell abandons Soft Landing target as he pursues growth slowdown

Operating margin trends were worse than forecast, Wilson noted, adding that he expects this negative trend to continue.

“The P/E multiple is wrong not because the Fed is going to be aggressive, but because the stock market is too bullish on the earnings outlook,” Wilson said, referring to the price-to-earnings ratio. “Multiples will start to come down as earnings come down, and then somewhere in the middle of that earnings-cutting process the market will go down, and we think that’s probably between September and December.”

At the June low, the S&P 500 was trading at 18 times earnings, a multiple that surpassed the bottom valuations seen in all of the previous 11 down cycles since the 1950s. The current P/E for the index sits above 19.

Meanwhile, S&P 500 earnings estimates for 2023 have been falling in recent weeks. Consensus earnings fell to a combined $6.60 per share for the next four quarters, with expectations for the third quarter taking the biggest hit, Bloomberg Intelligence strategists Gina Martin Adams and Wendy Song said in a note published on August 18.

As the Fed remains focused on economic data, Wilson believes the central bank will “always be behind by design” as it relies on two of the most lagging data points: labor market data and inflation.

“By the time the labor market collapses, it’s too late,” he said, since by then it will be obvious that the US economy is in recession. “The Fed is relevant, but I think we priced in most of the Fed’s pain after the first of the year,” he added.

Several Fed officials, most recently Cleveland Fed President Loretta Mester, independently emphasized their commitment to fighting four-decade high inflation this week, but remained unclear on how big their policy move will be next year. month.

Read more: Fed’s Mester supports rates above 4% early next year, no cuts in 2023

Fed Chairman Jerome Powell in a speech on August 26 at the Fed’s annual meeting in Jackson Hole, Wyoming, said reducing price pressures toward the 2% target was the Fed’s “primary concern.”

However, despite market volatility, energy stocks continue to outperform the broader index. That’s why Wilson, whose firm is sector neutral, suggested looking at the S&P 500 excluding that sector.

“When energy does well, it’s usually bad for everything else,” he said, adding that the divergence will continue. “Energy is really the antidote to everything else.”

(Updates with comments and adds chart)

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