The odds of a year-end rally in US stocks are fading as investors face a multitude of risks from elevated profit estimates to the Federal Reserve’s policy tightening, according to Morgan Stanley’s Michael Wilson.
The strategist — among the most bearish voices on US stocks — said he “would not be surprised” to see further declines in the S&P 500 with “earnings expectations likely too high for the fourth quarter and 2024, and policy tightening likely to be felt from both a monetary and fiscal standpoint.”
Wall Street analysts expect S&P 500 firms to post an earnings decline of 1.1% for the third quarter, before a rebound of 5.2% in the October-December period, according to data compiled by Bloomberg Intelligence. Forward 12-month estimates have also risen close to a record high.
Wilson’s pessimistic view has been somewhat vindicated, with the S&P 500 tracking its third straight monthly decline on worries of higher-for-longer interest rates. On Friday, the benchmark closed at 4,224 points, below its 200-day moving average for the first time since March. That’s considered a key technical support level and used by traders to assess whether the longer-term trend is up or down.
The combined outlook for earnings, valuations and policy means that the S&P 500 “will have a hard time” getting back above 4,300 to 4,400 points — which were previously considered levels of tactical support, Wilson said. The strategist has a year-end target of 3,900 — nearly 8% below current levels.
The chorus of Wall Street strategists warning about a subdued end to the year has grown in recent weeks as stocks also face renewed geopolitical risks. The macroeconomic uncertainty as well as US bond yields at 5% have overshadowed the third-quarter reporting season, causing S&P 500 constituents to increasingly move in unison.
Lackluster Reception
Early reactions to earnings are also lackluster. With about a fifth of S&P 500 members having reported, companies that lagged behind analysts’ estimates on the earnings-per-share metric have seen their stock underperform the benchmark index by a median of 3.7% on the day of results, according to data compiled by Bloomberg Intelligence. That’s the worst performance in the data’s history going back to the second quarter of 2019.
Even companies beating estimates have trailed the S&P 500 by 0.6% — the first such showing since the fourth quarter of 2020.
JPMorgan Chase & Co. strategist Mislav Matejka sees further pressure on global stocks from an expected strengthening in the dollar, he wrote in a note dated Oct. 23.
At RBC Capital Markets LLC, strategist Lori Calvasina also said the “outlook has become cloudier and we don’t think the pause in the S&P 500 rally is done yet.” Additionally, large-cap growth stocks are ripe for near-term declines as they’ve become “over-owned and overvalued,” while balance sheet concerns, rising bond yields and economic gloom are hitting small-cap firms, she said.
“The broader market, the growth trade and the small-cap trade are unlikely to find their footing again until the recent surge in bond yields comes to an end,” Calvasina wrote in a note.
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