Attention has shifted from interest rates and inflation to earnings growth and a looming recession. Morgan Stanley cautions investors against assuming that markets have priced in the bottom. But the firm still sees opportunity in the stock market, as reflected by its revamped fresh-money buy list, which contains nine stocks. The Federal Reserve’s moment of glory as the center of attention for market may have already passed.
As we roll out of 2022 and into the new year, investors have shifted their attention from rising interest rates and inflation to earnings growth and a looming recession, according to a December 19 note from Morgan Stanley.
Slowing demand means companies are rolling into an era of weak profitability. The firm’s chief US equity strategist, Mike Wilson, compares the coming earnings recession to something that could be similar to what transpired in 2008 and 2009, when markets failed to price in the severity.
Below is a side-by-side comparison of the two periods. The key takeaways include that earnings risk is just as high today as it was then. Meanwhile, the equity risk premium, which is the extra return investors seek above a risk-free rate, is lower.
The 10-year Treasury yield sit a few bases points off, and the S&P 500 and the next twelve months’ EPS revisions were also similar relative to the peak. The equity valuations in 2008 were more than 20% lower than they are today.
Morgan Stanley The lesson is that investors shouldn’t assume the market prices in severe outcomes until it happens.
To quantify the outlook, the firm’s 2023 EPS forecast for the S&P 500 is $195 with its bear case prediction at $180. While the index could reach lows between 3,000 to 3,300, the lower end is more likely. This is a departure from the consensus view, which predicts lows of approximately 3500-3600 on the S&P 500.
However, there are two contextual differentiators. In 2008, the central bank was slashing interest rates rather than raising them. Yet the firm doesn’t believe the dip will be as catastrophic because the housing market and banking system aren’t in the same kind of distress.
The good news is that amidst the gloomy view, there are still pockets of strength. Morgan Stanley has revamped its fresh-money buy list, which contains nine names it sees outperforming next year. Over time, the firm’s ever-changing group of elite stocks has outperformed the becnhmark S&P 500 by 18%.
Each of the nine stocks detailed below include the firm’s price target and the percentage growth remaining: