Top Wall Street Analyst Warns Of 'Proper Bust' In 2023: Stocks Are Trading In 'High Risk Zone'

A top Wall Street analyst has issued a cautionary note, warning of a potential sharp reversal in the stock market during the second half of 2023.

According to Michael Wilson, Morgan Stanley’s chief U.S. equity strategist and chief investment officer, the market’s headwinds presently outweigh its tailwinds, indicating a significant likelihood of a severe correction. Wilson’s estimate implies that the S&P 500 Index, tracked by the SPDR S&P 500 ETF Trust SPY may see a 10% drop in the second half of the year, with a target level of 3,900.

Why Is Morgan Stanley Near-Term Bearish On The Stock Market?

“A 20% rally does not guarantee [the] bear market is over,” Wilson wrote in his latest presentation.

The analyst drew on the historical parallel of the period immediately following World War II, between 1946 and 1949, when the S&P 500 made a double bottom after rallying 24% from the first low.

Chart: S&P 500 Index Price Action 1945-1949

This pessimistic outlook stems from Morgan Stanley’s lower-than-expected earnings forecast for the year, which anticipates pricing erosion and disappointing top-line performance.

“The Equity risk premium is at very unattractive levels, particularly given our earnings outlook,” Wilson said. The expert highlighted that stocks are trading in a “high risk zone,” susceptible to a sharp rise in the equity risk premium.

Headwinds From Restrictive Monetary and Fiscal Policies

Furthermore, Morgan Stanley noted that the United States’ economic policies are turning more restrictive, putting additional pressure on equities.

The liquidity environment is rapidly deteriorating, owing to record levels of Treasury issuance and quantitative tightening. Morgan Stanley predicts that bank reserves will shrink by $500-800 billion over the next six months, potentially lowering equity valuations. Wilson noted that the money supply growth is at the lowest levels since the 1930s.

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Fiscal support is expected to peak and reverse next month, potentially creating a headwind of 6 percentage points to nominal GDP over the next year.

The outlook is more optimistic for 2024, as Wilson expects another earnings boom following a “proper bust” in 2023.

Alternative Scenario? The Average Stock Will Fare Better, Value Will Stage A Comeback

Wilson also made recommendations for an alternative scenario.

Should his earnings forecast be incorrect, he expects market breadth to improve, with the equal-weighted S&P 500, as tracked by the Invesco S&P 500 Equal Weight ETF RSP, outperforming the market-cap weighted S&P 500.

The average stock is expected to fare relatively better both in a more optimistic and more pessimistic scenario, either by rising more or declining less.

Furthermore, Morgan Stanley believes that value stocks, as tracked by the Ishares Russell 1000 Value ETF IWD, may outperform growth stocks, which are tracked by the Ishares Russell 1000 growth ETF IWF as defensive sectors regain their previous year’s leadership.

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Chart: Year-to-date returns of S&P 500 (market-weighted and equal-weighted), Value and Growth Stocks