Michael Wilson from Morgan Stanley, the number one rated portfolio strategist in 2022, recently came up with his data-focus outlook for 2023.
The main theme is falling earnings per share, and given where the market prices are, he believes there are further downsides to go.
Here are some notes from his research.
Fire and Ice – Fire is inflation, and Ice is slowing growth. Together, they are pretty toxic, and when ice takes over the fire, they are more confident that bonds will beat stocks in this final phase that has yet to play out.
The ratio of equity to bond may show that bonds may outperform stocks.
Subsequent Rate Cuts Matches Recession and Further Equity Downsides
We all cheer about what rate cuts will bring, but usually, the window of opportunity is the period of pause often, the Fed will start lowering rate, which is usually done to combat recession.
Equities usually have ways to fall while Fed is still cutting rates (Exhibit 3)
EPS Growth Likely to Go Further Negative
Morgan Stanley’s leading earnings model was seldom wrong when viewed over the longer term. There were some short-term timing issues.
But the gap between indicator and actual S&P 500 last twelve months growth has never been this wide since 2008.
During periods of high inflation (CPI) the fall in earnings tends to be bigger. When the cost of goods sold + SGA expenses are positive (cost more than sales), the net income growth tends to be negative. The inverse relationship between net income growth and cost is there.
S&P 500 EPS Estimates and S&P 500 Forecast
Whether the scenario is pessimistic or optimistic, the EPS should come down, and based on reasonable P/E, the price target ranges between 3,500 to 4,200 for the S&P 500.
The average PE during earnings recessions: is 12.5 times. We have much to go.
Sector Preferences – Healthcare, Consumer Staples and Utilities
Small Cap Valuation and Performances
Morgan Stanley does not favour small caps relative to large caps due to higher earnings risks.
Small cap valuation, using P/E is cheaper relative to history and against the large cap.
Small-cap earnings have held up much better than the large-cap in 2022, but the earnings expectations in 2023 tend to be negative.
Equity Risk Premium is Thin Relative to History
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