The rally in US stocks ahead of the current earnings season presents a near-term risk to equities given the possibility of the Federal Reserve increasing interest rates and fading earnings growth, according to Morgan Stanley’s Michael Wilson.
This comes after the S&P 500 rose more than 6% in the last three weeks of March, in contrast to the sell-off in the run-up to the previous three reporting seasons, and is a cause for concern for Wilson – one of the most bearish voices on Wall Street.
“We believe this dynamic poses a near-term risk to stock prices given our more pessimistic outlook for earnings this year, especially as the liquidity picture becomes less favourable,” Wilson wrote in a note on Monday.
The strategist — who ranked first in last year’s poll of institutional investors after correctly anticipating the sell-off in stocks — doesn’t expect a drop in earnings growth until the third or fourth quarter of the year, contrary to analyst consensus estimates of a rebound in the second half.
“The data tells us that the business cycle continues to slow down and that the agreed 2023 earnings per share forecast remains materially very high,” he wrote.
The March rally in the S&P 500 was driven by a liquidity surge from authorities to ease the banking crisis at regional banks, though Wilson feels that is likely to change.
He said that while containing banking pressures is clearly positive, it could mean that the policy outlook for 2023 becomes less favorable for both liquidity and interest rates.
“Historically,” Wilson writes, “when future EPS growth becomes negative as it is today, the Fed lowers interest rates, not raises them.” However, inflation has held back the Fed, making this cycle a historical anomaly in this regard—and ultimately A near-term headwind for stocks, until the easing cycle begins.