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Stepan Lavrouk
Stepan Lavrouk
Articles (260) 

Morgan Stanley Sees Further Market Correction

The investment bank advises clients to wait for prices to decline further

March 19, 2019 | About:

In a research note published last week, Morgan Stanley (NYSE:MS) Chief Investment Officer Mike Wilson laid out the bank’s explanation for the recent market correction. The investment behemoth is still forecasting an earnings recession, repeating the call it made several months ago. The reason for this, in the bank’s view, is that rising labor costs will continue to compress margins for U.S. corporations, which will have a negative effect on earnings.

Growth not supporting price

“While we expected 2019 to be a much better year for investors than 2018, led by global equities, we were surprised by the persistence of the rally this year, given the more mixed fundamental outlook for growth that we have been seeing in the data. Perhaps we underestimated how out of position investors got at the end of last year. With the Fed pivoting on monetary policy so quickly, the pressure to keep up has overwhelmed the fact that growth may not be rebounding as soon or as fast as it needs to support higher equity prices from here.”

In other words, while 2019 has produced some impressive gains for investors, the underlying fundamentals do not necessarily support this latest bull run. In particular, cyclical parts of the market, like energy, semiconductors, financials and transportation, saw declines during the recent correction. On the other hand, as Wilson pointed out, defensive assets like long-term government bonds, utilities, real estate and telecommunications services all outperformed.

An earnings recession is still on the cards

“Our call for an earnings recession has received a lot of press in the last few months. However, most have dismissed it as either too shallow to worry about, or that it’s already bottomed. I think that conclusion is a bit premature given the margin pressure we observed in fourth-quarter earnings results in the U.S. This margin pressure makes perfect sense in the context of a U.S. economy that overheated last year. This overheating led to excesses in the supply chain via over-ordering and labor market tightness, and a capex boom. Inventories are now bloated, and labor costs are starting to now, which means that companies will need to cut back on orders and hiring. We saw some evidence of that in last week’s February labor report, which showed the lowest number of new jobs added and the highest hourly wages costs since the financial crisis.”

We discussed Morgan Stanley’s original call for an earnings recession several months ago. Since then, many companies have released their latest earnings reports, and the bank sees the telltale signs of margin compression in them. In addition to the surprisingly weak February jobs report, other economic indicators are showing signs of strain. For instance, core U.S. factory orders have declined for the third straight month, the longest weak streak since February 2016. With all of this in mind, Morgan Stanley expects the correction to resume and for stock prices to go lower:

“U.S. companies are typically quick to react to higher costs and will likely be no different this time. I expect to see more weak data until these margins stabilize, which may take longer than the market was starting to price a few weeks ago. Therefore, this correction makes sense and, ultimately, it is a good thing as it provides us with a good entry point for new investments. We just don’t think it’s over yet, and want to wait for lower prices before recommending that you put your cash to work. In the meantime, defensive parts of the market should continue to outperform.”

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About the author:

Stepan Lavrouk
Stepan Lavrouk is a financial writer with a background in equity research and macro trading. Specific investing interests include energy, fundamental geoeconomic analysis and biotechnology. He holds a bachelor of science degree from Trinity College Dublin.

Rating: 2.0/5 (1 vote)

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Comments

Valuator
Valuator - 6 months ago    Report SPAM

This guy is late to the earnings recession party: Global EPS is dead

But that won't be the reason for the inevitable resumption of the crash.

Please leave your comment:


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