Inflation has peaked and could rapidly decline next year, according to Morgan Stanley (NYSE:MS) equity strategist Michael Wilson, who called the recent consumer price index (CPI) and producer price index (PPI) reports a possible "trap" for "inflation bulls."
"The 200-WEEK moving average is a serious floor of support until companies fully confess or a recession officially arrives, both of which could take several more months and lead to a technical rally in the short term," he wrote in an analyst note.
If inflation declines, this would make the case for lower rates, which will be a catalyst for stocks until earnings are cut or we enter a recession.
See Also: Recession Is Imminent, This Wells Fargo Exec Says - How To Navigate The Bear Market
In past earnings recessions, it takes 15 months on average to play out. And we’re roughly three months in the downward earnings per share (EPS) revision cycle, from its peak in early July, Wilson reported.
Morgan Stanley expects an acute and material earnings deceleration over the next 12 months, as the market multiple discounts the earnings downside between 40% to 50% of the way through the EPS compression.
Due to the speed of the cycle, the downtrend in earnings may be shorter than the average. The next three to four months is when stocks will fully discount the earnings recession, the note continued.
Also Read: Roblox Analyst Says Market Hasn't Grasped Monetization Potential
Bulls And Bears
In the third quarter earnings season, Morgan Stanley is looking for margin degradation, excess inventory, and full-year 2023 guidance.
If third-quarter earnings do not bring revisions to the 2023 EPS forecasts, then it is not likely these are the final price lows of this current bear market, Wilson says.
In order for stock prices to reach levels low enough for a bear market to reverse into a new bull market, it may be the fourth quarter earnings season that paints a clearer picture for 2023.
The bear market rally could last until the S&P 500 hits 4,000 or the 200-day moving average is found at 4,150, which is less likely.
This may seem like a large leap, but it is in line with prior bear market rallies. It typically takes a full recession to fall below the 200-week moving average, Wilson explains.
If the S&P 500 falls below the 200-week moving average, then we can expect the markets to decline to 3,400 or lower.
The 200-week moving average will eventually weaken like it typically does when earnings forecasts fall by 20%, he predicts. The final stock price lows for this bear market are likely to be closer to between 3,000 and 3,200 for the S&P 500.
P/E's, And Which Sectors Boast Positive Risk Scores
- P/E’s (price-to-earnings ratios) have dropped by 30% this year
- They remain above the average P/E observed at the trough of prior bear markets
- If earnings estimates are correct, P/E’s are close to fair value, but we are still above the average compared to past bear markets
- If interest rates do not fall, or the Fed does not pivot, then there won't be a meaningful market rally
- Morgan Stanley favors the healthcare sector heading into the end of the year due to favorable risk/reward
- Other sectors with a positive risk score include real estate, telecommunications, utilities, banks, and food and staples retailing. For example, UnitedHealth Group (NYSE:UNH) and PepsiCo (NASDAQ:PEP) posted strong third-quarter earnings, and both companies lifted their full-year earnings outlook for the year.
