Analysts from Morgan Stanley have warned investors that they seem to have forgotten the cardinal rule of “Don’t Fight the Fed”, and that this week’s Federal Open Market Committee (FOMC) meeting may serve as a reminder. The central bank is widely expected to raise its target federal-funds rate by 25 basis points (a quarter of a percentage point) to a range of 4.5% to 4.75%.
Michael Wilson, Morgan Stanley’s chief equity strategist, believes better price action in stocks has convinced many investors they are missing something, prompting them to participate more actively. However, Wilson and his team are surprised by the magnitude of the recent advance and believe it is “just another bear-market trap.”
The analysts are leaning more toward their bear case of $180 based on the margin degradation and what their earnings models are projecting. Wilson warned that typically when forward earnings growth goes negative, the Fed is actually cutting rates, “which is an additional headwind for equities.”
Wilson has also warned investors not to invest in this month’s stock rally as downbeat earnings are ahead. He recently reminded investors that the “final stages of the bear market are always the trickiest” and urged them to “trust your own work” and ignore the noise.
Small-cap stocks often experience a surge in price during the month of January following the tax-loss harvesting of generally illiquid equities in December, a phenomenon known as the “January Effect” However, Wilson is adamant that the rally is more likely to fade based on month-end rebalancing and the upcoming FOMC meeting, whose 12 members determine monetary policy.
Wilson believes the market is underestimating businesses' inability to balance out costs and revenue, and that sticky inflation is eating into company profits. He also warned that markets aren't paying enough attention to a so-called negative operating leverage cycle, where companies' costs appear to be rising faster than sales.
Even as signs of a slowdown mount, investors are rewarding companies that exceed expectations and dialing back the punishment of those that fall short. Morgan Stanley economists are maintaining their forecast for a “softish” US economy and anticipate that, if a recession does occur, it will be more moderate than what is generally expected.
0. “Morgan Stanley’s Mike Wilson warns the stock market’s January rally could end this week” MarketWatch, 30 Jan. 2023, https://www.marketwatch.com/story/morgan-stanleys-mike-wilson-warns-the-stock-markets-january-rally-could-end-this-week-11675107367
1. “Morgan Stanley sees 25 basis points rate hike in next US monetary policy meet” ThePrint, 30 Jan. 2023, https://theprint.in/economy/morgan-stanley-sees-25-basis-points-rate-hike-in-next-us-monetary-policy-meet/1342964/
2. “Don’t Buy the Rally as Fed Looms: Morgan Stanley” ThinkAdvisor, 30 Jan. 2023, https://www.thinkadvisor.com/2023/01/30/dont-buy-the-rally-as-fed-looms-morgan-stanley/
3. “The stock market is underestimating sticky cost inflation that's eating away at company profits, says Morgan Stanley's Mike Wilson” Yahoo Canada Finance, 25 Jan. 2023, https://ca.finance.yahoo.com/news/stock-market-underestimating-sticky-cost-125241273.html
4. “World’s top stock strategist says investors are falling into a trap—again” Fortune, 23 Jan. 2023, https://fortune.com/2023/01/23/stock-strategist-sp500-trap-investors-morgan-stanley-recession-inflation-economy-earnings-2023-forecast
5. “The stock market is underestimating sticky inflation biting profits: Mike Wilson” Markets Insider, 25 Jan. 2023, https://markets.businessinsider.com/news/stocks/stock-market-inflation-sticky-falling-earnings-mike-wilson-morgan-stanley-2023-1
6. “Top Strategists At Morgan Stanley And JP Morgan Are Skeptical Of Stock Market Rally” Moguldom, 30 Jan. 2023, https://moguldom.com/435271/top-strategists-at-morgan-stanley-and-jp-morgan-are-skeptical-of-stock-market-rally
7. “Morgan Stanley Economists Stick by ‘Softish’ Landing US Forecast” Yahoo! Voices, 22 Jan. 2023, https://www.yahoo.com/now/morgan-stanley-economists-stick-softish-061257780.html