Morgan Stanley Warns ‘Imminent’ Earnings Recession Will Tank Stocks—But Here’s When The Bear Market Could End

Topline

As earnings season kicks off, Morgan Stanley’s investment chief is warning clients that incoming reports will likely disappoint investors, pushing major stock indexes to two-year lows even if the economy ultimately avoids a recession—but on the bright side, the analyst foresees the bear market’s end could be in sight and may arrive as early as this quarter.

This year’s market rally looks particularly vulnerable since it’s been led by “low-quality, heavily … [+] shorted stocks,” Morgan Stanley’s investment chief tells clients.

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Key Facts

“We’re not biting on this recent rally,” Morgan Stanley’s Michael Wilson told clients in a note as stocks surged Monday, with the S&P 500 and tech-heavy Nasdaq up nearly 5% and 9% for the year after crashing 19% and 33%, respectively, in 2022.

With consumer spending slowing down and high costs still cutting into profits, Wilson says an earnings recession is “imminent,” and that fourth-quarter profits set to be released in the coming weeks will disappoint investors, at least according to Morgan Stanley forecasts that are significantly lower than average analyst estimates.

The last two times the bank’s model predicted earnings so far below average forecasts (during the dot-com crash and Great Recession), the S&P fell 34% and 49%, Wilson warns, noting this year’s rally looks particularly vulnerable since it’s been led by “low-quality, heavily shorted stocks”; meme stocks AMC and GameStop, for example, have surged 45% and 23%, respectively.

Morgan Stanley ultimately projects the S&P could tumble as much as 25% to a two-year low of 3,000 points as earnings season ramps up, but Wilson notes that once the quarterly reports reveal the extent of companies’ woes, the bear market will ultimately come to a close—either later this quarter or early in the second.

Despite being more bearish than most, Morgan Stanley isn’t alone in warning the rallying market could be a headfake: Goldman Sachs analysts last week said the S&P will crater up to 22% this spring if the economy falls into a recession, and even if it doesn’t, they foresee the index falling another 10% before the ending the year roughly flat at current levels.

Crucial Quote

“When costs are growing faster than sales, profit margins erode. This is the norm during any unexpected revenue slowdown,” says Wilson, explaining sales tend to fall off quickly and unexpectedly, while costs remain high. “That’s exactly what is happening in many industries already, and this without a recession.”

Key Background

The stock market collapsed last year as the Federal Reserve’s interest rate hikes started to slow down the economy in a bid to tame inflation, effectively reversing a slew of outsize stock gains bolstered by government stimulus efforts during the pandemic. Amid the weakness, major corporations slashed more than 100,000 jobs last year, with the layoffs only intensifying in recent weeks as tech heavyweights Alphabet and Amazon announce their own cost-cutting measures. Fourth-quarter earnings season kicked off earlier this month with a slew of big banks reporting a mixed bag of results. Among the hardest hit, Goldman shares tanked more than 6% after the firm’s worst earnings miss in a decade.

What To Watch For

Earnings season is just getting started and will drag on over the next month, with a slew of technology firms—including Tesla, Microsoft and IBM—expected to report this week, followed by Apple, Amazon, Meta and Alphabet next week.

Further Reading

Spotify, Alphabet And Meta Lead Tech Stock Surge After Massive Layoff Announcements (Forbes)

Here’s What Big Bank Earnings Revealed About The Economy (Forbes)

Tesla And These Other Stocks Could Withstand Recession (Forbes)