Morgan Stanley chief equity strategist Michael Wilson has received plaudits across Wall Street for correctly anticipating that asset prices would plunge this year as the Federal Reserve moved to pop the post-COVID asset bubble with aggressive quantitative tightening.
But while the first part of this rough patch for markets was mostly motivated by rising interest rates, intended to help curb inflation, Wilson expects the next leg lower for stocks will be driven by a decline in expectations for corporate earnings, which — in combination with higher interest rates — could help spark a significant re-evaluation of the equity risk premium.
Since last year, Wilson has stood by his thesis, which he has couched in the language of the Robert Frost poem “Fire and Ice”.
More recently, Wilson has said that the Federal Reserve’s decision to dash expectations for a near-term “pivot” back toward looser monetary policy has inspired “Fire and Ice Part Deux.”
In an interview with Bloomberg Radio on Wednesday, Wilson suggested that Wall Street has failed to anticipate a sharp drop in earnings per share heading into next year.
“The earnings story is what we’re focused on,” he said.
“The end game for us is all about earnings and growth and we’re just not optimistic,” he added.
Wilson’s “bull case” anticipates that the U.S. economy might avoid a recession, but in this scenario equity valuations would still suffer from lower earnings.
“The bull case is soft landing for the economy but that’s not a soft landing for earnings,” he said.
As the Fed pulls back from a decade-plus of stimulative monetary policy, Wilson anticipates that investors will soon shift their focus to fiscal policy.
“Fiscal policy is working counterproductively to monetary tightening,” Wilson said, citing the recent federal student-loan forgiveness and the Biden Administration’s Inflation Reduction Act, which offers subsidies for clean energy.
Asked about his expectations around Wednesday’s interest-rate decision from the Federal Reserve, Wilson said he wouldn’t be surprised to see stocks rally “after the Fed does their thing.”
When it comes to potential bright spots in the economy, Wilson said investors should look at managed-care stocks. Some examples of stocks that fit this description include UnitedHealth Group
and Humana Inc.
“These are growth stocks, but they’re not priced as growth stocks,” he said.
U.S. stock index futures were pointing toward a higher open on Wednesday for the S&P 500
and Dow Jones Industrial Average
as investors wait to see whether the Fed will hike interest rates by 75 basis points, or possibly deliver a more hawkish surprise with a 100 basis-point hike.