One of the largest investment banks in the world has officially forecasted an earnings recession.
Last week, Michael Wilson, chief investment officer and the head of the Morgan Stanley’s (MS, Financial) U.S. equity strategy department laid out the bank’s thinking on the coming year. Wilson, who previously held an annual 4.3% growth estimate for the S&P 500, has cut his target to just 1%, and believes that Street analysts are being far too bullish on the market. For instance, Bloomberg puts the average analyst growth target at 5.4%. Wilson outlined his thinking in a research note Monday.
The Fed’s rate pivot was well-received
From the note:
“As expected, the Federal Reserve delivered on their part of the bargain last Wednesday by telling us that they would not be raising interest rates again any time soon. They also intimated that they are willing to use their balance sheet to make sure financial conditions don’t tighten like they did in December. Investors took this to mean that the Fed’s quantitative tightening is coming to an end this year as well. We agree with this interpretation, and that’s a positive for asset prices. However, stocks have rallied a lot this year starting on January 4th when Fed Chair Jay Powell began to hint that the Fed was beginning to pivot on last year’s tighter monetary policy.”
Wilson attributed the post-Christmas rally to communications from the Federal Reserve that the central bank would be changing course and postponing rate hikes. The problem is that the market seems to have conflated a temporary stalling of hikes with the cessation of quantitative tightening altogether. There is a world of difference between these two extremes, and it is likely that investors are finally waking up to that. So long as the Fed refrains from turning the tap of cheap money back on, we are unlikely to see the bull market come back any time soon.
Earnings growth is still slowing
“Regular listeners know that tighter monetary policy and financial conditions have been one of our major concerns for the past year, so it should come as no surprise that this pivot by the Fed makes us more constructive on equity markets. The problem is that our other concern: slowing earnings growth, has not been resolved. In fact, fourth quarter earnings season has led to one of the most negative earnings revision cycles that we can remember. First quarter consensus year-over-year earnings growth is now down to zero. Based on the trajectory and breadth of these revisions, I think it will soon move into negative territory, and even spill over into second- and third quarter earnings expectations.”
We have noted previously how rare it is for major investment banks to exude such negative sentiment on the market’s prospects. The problems of slowing corporate growth cannot be solved in a single quarter, and it is likely that there will be more selling before we bottom out. Moreover, now that the positive fiscal impact of the Trump administration’s tax cuts has faded, there is not a lot of firepower available to boost flagging top- and bottom-line figures.
Advice for the future
“In short, while we expect a bottom in earnings growth this year, we’re not sure about the depth and timing of that bottom. With stocks up significantly since December’s lows, we agree with the Fed that it’s time to be patient. That means don’t chase markets higher here. I remain confident that there will likely be a pullback to buy at lower prices, even if December will ultimately prove to be the low for the vast majority of stocks.
For those of you who bought stocks in December as they were falling, you likely have some nice gains at this point. If these investments are worth longer-term money, our advice is to do nothing and hang onto them. For more trading-oriented money, you can take some profits here. For those of you who did nothing in December, it’s time to wait for the next pullback, which could begin soon. Look to buy that pullback with a focus on emerging markets and the more cyclical parts of the equity market in the US.”
Wilson’s advice is to sit tight and wait for the next sell-off. Most value investors will likely have sat out this late-cycle bull market anyway, as valuations have been high across the board, so this is not new advice. But it is still telling that a head strategist at a major investment bank is so bearish on 2019. Good things come to those who wait, and there will likely be plenty of opportunities to go around before the year is out.
Disclosure: The author owns no stocks mentioned.
