The earnings recession continues to be coming, and it will be worse than anybody thinks, Morgan Stanley mentioned in a brand new be aware to shoppers on Monday.

The agency sees a “significant” earnings recession this yr, with earnings declining 16% by the top of the yr earlier than experiencing a “sharp rebound” in 2024.

“This out-of-consensus earnings path is supported by our fashions and our view that coverage will develop into extra accommodative in 2024, not 2023,” Morgan Stanley chief funding officer Michael Wilson wrote. “It is also supported by our thesis that we’re within the midst of a number of ‘hotter however shorter’ earnings cycles within the context of a broader secular bull market (a “growth/bust/growth” regime).”

Wilson and his workforce nonetheless see the S&P 500 falling from its present ranges, which is presently up almost 20% from the October 2022 backside. The assumption is that the S&P 500 will fall to three,900 by yr finish, and the S&P 500 will produce earnings per share of $185. Morgan Stanley’s 2023 S&P 500 earnings per share goal, which was revised down from $195 right now, is 17% under market consensus, in accordance with the agency.

Morgan Stanley is not alone in saying issues are getting a bit of too rosy for shares. Earnings for S&P 500 firms have declined in comparison with the identical quarter final yr for 2 straight quarters now, in accordance with Factset. Evaluation from Bespoke Funding Group exhibits traders have not wager this closely on a drop within the S&P 500 since 2007. And economists proceed to warn that an financial slowdown is coming whether or not the Federal Reserve continues to hike rates of interest or not.

All of the whereas, shares have surged, with the Nasdaq now up almost 10% within the final month. The S&P 500 ahead price-to-earnings ratio is now within the high 20% of historic ranges relationship again to the Eighties, per Morgan Stanley. And AI targeted names like Nvidia (NVDA), Marvell Expertise (MRVL) and most just lately MongoDB (MDB) have soared following bullish commentary on the prospect for AI of their enterprise.

Whereas not bearish on the general know-how, Morgan Stanley’s equities workforce is not shopping for a seat on the AI hype practice to steer traders to new market highs in 2023.

“Whereas there’ll undoubtedly be particular person shares that ship accelerating progress from spending on AI this yr, we don’t suppose it is going to be sufficient to vary the trajectory of the general cyclical earnings pattern in a significant method as high line decelerates and price pressures stay sticky,” Wilson wrote. “Consequently, we are actually firmly out of consensus on our earnings view.”

“The truth is, the one different occasions the unfold between our earnings mannequin and consensus has been this large had been August 2008 and late 2001, each threat off intervals for equities.”

The place to cover from the ‘cyclical bear’

Whereas Wilson and his workforce nonetheless see a broader secular bull market, they consider a cyclical bear market is coming. The bear market is coming for earnings as markets have too shortly neglected lagging impacts of the rising rate of interest surroundings.

Morgan Stanley likens the surge in shares all through 2021 after which the following collapse in 2022, to publish World-Struggle II when the economic system additionally struggled, as it’s now, to handle extra financial savings and maintain costs down.

This may result in the tactical correction in among the shares, and the narrowly pushed S&P 500, which have as soon as once more been bid up in 2023, Morgan Stanley argues.

When that occurs, the trail will play out as follows: The Fed’s coverage will develop into extra accommodative for progress however that can include rate of interest cuts in 2024, not late 2023 as futures markets presently point out might occur.

In that occasion, Morgan Stanley likes “conventional defensive areas” like healthcare client staples and utilities.

“We choose defensive positioning for the powerful earnings surroundings that we anticipate to proceed and search for sectors and business teams with dependable monitor information of outperformance late within the cycle/throughout earnings recessions,” Wilson wrote.

Josh is a reporter for Yahoo Finance.

Click on right here for the newest inventory market information and in-depth evaluation, together with occasions that transfer shares

Learn the newest monetary and enterprise information from Yahoo Finance

Adblock take a look at (Why?)