The bear market isn't done yet and stock valuations are 'significantly disconnected' from reality, Morgan Stanley says

  • Stock valuations are disconnected from economic and earnings reality, according to Morgan Stanley. 
  • The bear market is not yet complete and stocks have room to fall, analysts led by Mike Wilson wrote Monday. 
  • The current macro, policy, and corporate earnings landscape is not favorable for stocks. 

Stocks have room to fall, and the bear market isn’t finished just yet, according to Morgan Stanley equity strategist Mike Wilson. 

In a Monday note, analysts led by Wilson wrote that the equity market has gotten ahead of itself by anticipating an extended pause in rate hikes from the Federal Reserve, leaving valuations “significantly disconnected from economic/earnings reality.”

Even though consumer price inflation cooled to an annual rate of 8.5% in July from 9.1% in June, Morgan Stanley said it likely has not eased fast enough to justify the sustained Fed pause that markets have already priced in.

Easing financial conditions and a strong jobs report likely further lower the odds for a dovish pivot, analysts wrote. Plus, lower earnings revisions combined with sustained, higher wage costs will drag on stocks.

The current market is starkly different from three years ago, when policymakers maintained a durable pause in the Fed Funds Rate and the market rallied, the analysts said, noting that business and consumer sentiment is much more depressed now than it was in 2019.

“Bottom line: the equity market has already discounted a durable Fed pause, the likelihood of which is low to begin with,” analyst wrote. “That development leaves equity multiples significantly disconnected from fundamentals which continue to suggest we’re in a late cycle, slowing growth environment.”

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