Morgan Stanley expects a sudden drop in US earnings of 16% to kill the rally

(Bloomberg) — Morgan Stanley strategists expect a sudden drop in corporate earnings to rein in a rally in US stocks, a call that runs counter to Wall Street estimates.

Most Read from Bloomberg

Instead, they are bullish on equities in Japan, Taiwan and South Korea and recommend an overweight position in developed market government bonds, including long-term Treasuries, and the dollar.

Earnings per share for the S&P 500 are set to drop 16% this year, according to Morgan Stanley strategists led by Andrew Sheets. This is one of the more bearish forecasts among those tracked by Bloomberg, and contrasts with bullish forecasts from the likes of Goldman Sachs Group Inc. , which expects moderate growth.

“We believe the downside risk to US earnings is now,” Morgan Stanley analysts wrote in a note published on Sunday. “While a deteriorating liquidity backdrop is likely to put downward pressure on equity valuations over the next three months, we also see EPS disappointing ahead as revenue growth slows and margins shrink further.”

Morgan Stanley expects earnings per share for the S&P 500 to come in at $185, compared to the median prediction of $206 from the strategists. Sheets sees the gauge at 3900 year-end versus Friday’s close of 4282.37. The index is on the verge of a bull market after rising 19.7% from its October low, gaining amid enthusiasm for AI stocks despite a rate hike by the Federal Reserve and concerns about a potential recession.

Other recommendations from the bank’s strategists include defensive stocks, investment-grade bonds in developed markets, and, for yield-hungry investors, preferring extra-grade securities — a type of secondary bank debt — over high-yield bonds.

Story continues

Certainly some strategists are more optimistic than those at Morgan Stanley. The Evercore ISI team led by Julien Emmanuel raised its target for the S&P 500 for the year-end index by 7.2% to 4450. They said that easing inflation likely signals a pause for the Federal Reserve and that dollars “delivered during the darkest days of the pandemic” will support the stock market.

(Updates with chart and views of Evercore ISI strategists)

Most Read by Bloomberg Businessweek

© 2023 Bloomberg LP