- US equities have further downside, and investors should maintain a defensive posture, Morgan Stanley said Monday.
- Bank strategists said traders are becoming too “optimistic” given several more weeks of “winter” ahead.
- The bank detailed three reasons why investors should not be too bullish about the stock market outlook.
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After a volatile start to the year, US equities have further downside to go, and investors should maintain a defensive posture, Morgan Stanley said in a note on Monday.
Bank strategists, led by Michael Wilson, said traders are becoming too “optimistic” given several more weeks of bearishness for the stock market outlook.
“Winter is here and Punxsutawney Phil says we got at least 6 more weeks,” they said, reiterating a late-January warning to play defense. “We agree and think it could even bleed well into spring. Earnings risk is increasing for wider swath of the market than most investors expect as rising inventories meet waning demand.”
US equities have caused whiplash in the past weeks as investors come to terms with a more hawkish
determined to tighten monetary policy to cool inflation.
Here are three reasons why Morgan Stanley believes investors should stay on defense:
1. Earnings are slowing down
The percentage of fourth-quarter earnings that are beating estimates so far is heading back to the long-term average of 5%, which is well below the 15%-20% seen in the past 18 months that marked “a period of over earning,” the strategists said.
“The key question now is whether we are going to return to ‘normal’ or will we experience a period of under earning first — i.e. payback?” they added.
This payback, they said will likely be in the first half of the year as fiscal stimulus fades, monetary policy tightens, and demand catches up with the markets.
“Earnings revision breadth leads and recent trends suggest we are headed in that direction,” they said. “The companies with the greatest earnings risk remain those businesses that benefitted from the pandemic pull forward the most.”
2. Consumer confidence is in the tank
In the last few weeks, the strategists saw companies — including Netflix, Facebook parent Meta, and PayPal — that weren’t expected to see such earnings “payback” post disappointing results and weak guidance. This suggests the so-called payback may be deeper and wider than initially anticipated.
“There is a little Peloton in everyone,” they said, citing the fitness company’s overestimation of future demand for its products and services. “We suspect there will be more surprises on this front … Consumer confidence remains in the tank due to higher prices.”
On top of this, the strategists said there is also increasing evidence that consumers may simply be in a worse position to spend even if they would like to.
“Consumer spending is at risk and it’s not all due to Omicron,” they said. “Instead, it is more a combination of government transfers running as prices rise to levels of demand destruction.”
3. Inventory builds aren’t necessarily good for earnings
The bank strategists said while inventory restocking could drive economic growth, there is a risk if demand does not meet supply. They also said they remain skeptical this would eventually ease into a smooth “goldilocks transition.”
“We think it could also reveal the high amount of double ordering in many industries,” they said. “Order cancellations will only exacerbate the already weakening demand.”
How should investors position themselves?
“What you need to be doing right now as an investor is looking for areas that have already corrected or areas where there’s probably pent-up demand,” Wilson told CNBC Monday, citing consumer services, health care, and parts of technology as sectors that have corrected. “It is the year of the stock picker. It’s not about the index anymore.”
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