The stock market has more downside ahead as rising inflation continues to weigh on consumer sentiment, Morgan Stanley's investment chief says

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Many economists expect US consumer spending to keep the economy growing.Alexander Spatari/Getty Images

  • The stock market still has more downside ahead as persistent inflation weighs on consumer sentiment, according to Morgan Stanley’s Mike Wilson.

  • The firm sees the S&P 500 trading another 16% lower over the next year in its bear-case scenario.

  • “We continue to believe that the US equity market is not priced for this slowdown in growth from current levels,” Wilson said.

The stock market isn’t out of the woods yet even when accounting for its current decline, according to Morgan Stanley’s investment chief Mike Wilson.

In a Tuesday note, Wilson reiterated his view that persistent inflation and a deceleration in corporate earnings means there’s still more downside ahead for stocks.

“The key implication here is that the early-to-mid-cycle benefits of positive operating leverage are behind us, and earnings growth is likely to decelerate, driven by margin compression and slowing top-line growth,” Wilson said.

In his base case scenario, Wilson expects the S&P 500 to trade at 3,900 one year from now, representing potential downside of 3% from current levels. But in Wilson’s bear case scenario, the S&P 500 would trade 16% lower to 3,350.

“We continue to believe that the US equity market is not priced for this slowdown in growth from current levels. In fact, based on our fair value framework, the S&P 500 is still mispriced for the current growth environment,” Wilson said.

That’s because inflation has been exacerbated by Russia’s war against Ukraine and China’s sporadic COVID-19 lockdowns, which continues to weigh on “already depressed consumer sentiment.”

Meanwhile, rising labor and input costs could be sticky and put downward pressure on corporate profit margins, and tightening monetary policy is already having a negative economic impact, especially on the housing market as mortgage rates soar.

All-in, the current market and economic environment validates Wilson’s long held view that a combination of “fire” and “ice” would roil risk-assets, where as fire is a nod to tightening monetary policy by the Fed, and ice references a slowdown in corporate earnings.

Wilson expects the earnings per share of the S&P 500 to grow only 8% in 2022, 5% in 2023, and 0% in 2024. That compares to analyst estimates for 10% growth in 2022, 10% growth in 2023, and 9% growth in 2024.

“Bottom line: ‘fire’ and ‘ice’ persist as the Fed continues to tighten policy into a slowing growth environment. Expect decelerating earnings growth, a lower multiple and elevated volatility,” Wilson concluded.

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