To a large extent, at least among the major Wall Street banks, Morgan Stanley is credited with accurately forecasting the stock market’s turbulent ride this year.
According to the strategist at Morgan Stanley, Mike Wilson, there is more suffering on the horizon, but for a different cause.
The significant decline in U.S. stock prices seen this year, as measured by the S&P 500 index’s decline of 18%, can be attributed to the rise in interest rates. At the lows in June, price-to-earnings ratios were actually 9% higher than they had been at the beginning of the month. This is despite the fact that estimates for earnings per share for the next 12 months have only decreased by 1.5%.
The Federal Reserve has emphatically dashed hopes for a dovish pivot, and as a result, Morgan Stanley believes that the asset markets are likely to enter new turbulent times. According to Wilson, in contrast to the first half, the decrease in stock prices this time will come about mostly as a result of a larger equity risk premium and lower earnings rather than higher interest rates.
According to Morgan Stanley, the earnings model it uses, which is based on inputs such as the ISM manufacturing survey, the consumer confidence index published by the Conference Board, housing starts, and credit spreads, implies a significant decline in earnings is on the horizon. Another model, which is mostly based on data from the Fed’s regional banks, also predicts that earnings will go down.
The difference between the return that an investment in the stock market delivers in comparison to a risk-free rate is referred to as the equity risk premium.
Wilson, however, claims that the company is more confident now that bond prices have reached their bottom. The yield on the 10-year Treasury was 3.19% on Friday.
If last Friday marked a short-term bottom for long-duration bonds, which are characterized by high yields, the S&P 500 and many equities may receive some respite if rates continue to decline in the lead up to the next round of earnings reductions. However, it is important to note that when the fall weather becomes chillier, so will growth, which will put a significant amount of pressure on stock prices given the meager return on investment (ERP) investors are getting paid to take this risk, he added.
On Monday, in commemoration of Labor Day, the United States stock market was not open for trading. The closure of an important gas pipeline in Europe resulted in a precipitous drop in stock prices.
