• Morgan Stanley CIO Mike Wilson has been calling for an S&P 500 backside between 3,000-3,300.
• He mentioned in a word on Sunday that buyers will not be appropriately pricing in dangers.
• China-Taiwan tensions, the debt ceiling standoff, and a credit score crunch threaten shares, he mentioned.

Morgan Stanley’s Mike Wilson is as soon as once more urging buyers to proceed with warning, warning that dangers proceed to pile up for shares regardless of the current rally.

In a word to purchasers on Sunday, the financial institution’s chief funding officer and chief US fairness strategist mentioned that the S&P 500’s is due for a reversal in fortune after near-10% returns up to now year-to-date, and that buyers are too optimistic about prospects for the economic system and shares.

“Final week’s worth motion confirmed indicators of panic shopping for by buyers who’re afraid they will miss the following bull market,” mentioned Wilson, who was probably the most correct forecaster amongst main Wall Avenue strategists in 2022. “We imagine it will show to be a head pretend rally like final summer season’s, for a lot of causes.”

First amongst these causes is that valuations stay traditionally excessive, Wilson mentioned. Larger valuations would possibly imply poorer future returns, and decrease valuations permit for greater upside potential.

Wilson pointed to the median ahead price-to-earnings ratio amongst S&P 500 shares of 18.3x as one piece of proof that the index is overvalued as an entire. 

“The S&P 500 median inventory ahead P/E is eighteen.3x (within the high 15% of historic ranges again to the mid-Nineties), the S&P 500 ex-tech median P/E is eighteen.0x (additionally inside the high 15% of historic ranges) and the fairness danger premium is simply 200bp,” he mentioned. 

Valuations are tied to efficiency expectations, which Wilson says are additionally too excessive. Traders are anticipating higher earnings efficiency than they need to on condition that hawkish Federal Reserve coverage is prone to weigh on financial progress, Wilson believes. 

He mentioned Morgan Stanley’s ahead earnings fashions exhibits an earnings recession forward.

“A really wholesome reacceleration is baked into 2H consensus earnings estimates (mid-to-high single-digit progress for each the general index and the index ex-tech). This flies immediately within the face of our forecasts, which proceed to level materially decrease,” he mentioned.

He continued: “We stay extremely assured in our mannequin given how correct it has been over time and not too long ago. We first began speaking in regards to the coming earnings recession a yr in the past and acquired very sturdy pushback, identical to right this moment. Nonetheless, our mannequin proved fairly prescient primarily based on the outcomes and is now projecting a way more dire end result than consensus. Given its historic and newer monitor report, we expect consensus estimates are off by as a lot as 20% for this yr.”

Wilson is asking for the S&P 500 to backside out someplace between 3,000-3,300. With the index at the moment buying and selling round 4,200, a drop to three,000 could be a 28% decline.

6 different causes to not belief the rally

Within the word, Wilson listed a bunch of different causes he is so bearish within the near-term, a lot of them related to what he thinks are misguided investor expectations.

One is that the Fed is unlikely to reverse its charge hikes this yr, because the market continues to anticipate. Even when the central financial institution did, it will both imply {that a} recession is underway, banking system stress is worsening, or inflation is slowing due to weaker progress, which is dangerous for shares. 

One other is that buyers aren’t pricing in a credit score crunch state of affairs following the closures of Silicon Valley Financial institution, Signature Financial institution, and First Republic Financial institution.

“There’s additionally a presumption that the banking scenario is not going to worsen and grow to be systemic. Whereas we do not assume that is 2008-09, we do assume it’s going to speed up the credit score crunch that was already prone to start by year-end, primarily based on mortgage officer surveys from January,” Wilson mentioned.

The chart beneath exhibits the outcomes from the surveys Wilson mentions: a rising variety of banks are saying they’re pulling again on lending.

Weakening shopper confidence and apathy across the struggle in Ukraine and tensions between China and Russia additionally threaten to sink shares, he mentioned. 

And naturally, there’s the ongoing debt ceiling standoff. Wilson mentioned he bets this would be the set off for shares to show decrease. The deadline to lift the debt ceiling is anticipated to hit someday in June. 

“Whereas a debt ceiling decision removes a near-term market danger, a cloth dislocation was by no means priced in and the larger danger for markets now could be that elevating the debt ceiling may lower market liquidity primarily based on the sizeable Treasury issuance we anticipate over the six months after it passes,” he mentioned.

From a technical perspective, Wilson additionally mentioned that market breadth is weak. In different phrases, a lot of the market’s returns are being pushed by inflows to huge shares on the high of the index. In This autumn final yr, the rally was extra widespread and was pushed by much less speculative areas of the market.

Whereas Wilson is among the most bearish strategists on Wall Avenue within the brief time period, he expects the index to recuperate to three,900 by year-end. That is just under the median of 4,000 amongst main Wall Avenue strategists, and represents about 7% draw back from present ranges.