The world’s top stock strategist says an “earnings slump” is coming for markets, and it could be similar to what happened during the 2008 financial crisis.

In bear markets, stocks don’t usually fall in a straight line.

In the last 50 years, even in the worst financial crises of the modern era, there have been brief rallies 6.5 times on average per bear market.

As expected, this year has been is no different. But all by the wayMorgan Stanley chief investment officer and US equity strategist Mike Wilson has warned investors to avoid falling into these “bear market traps”.

And even after a more than 20% drop in the S&P 500 this year, Wilson, who was given the nod as the world’s leading best stock strategist in the last institutional investor survey—believes stocks will fall further. Investors have focused too much on the Federal Reserve’s rate hikes and inflation, he argues, when the real problem is declining economic growth and corporate profits.

“The earnings recession itself could be similar to what happened in 2008/2009,” Wilson wrote in a research note Monday. “Our advice: don’t assume the market is pricing in this type of outcome until it actually happens.”

Wilson believes the S&P 500 will sink to between 3,000 and 3,300 in the first quarter of 2023 from about 3,800 today. And by the end of next year, he expects the index to recover to just 3,900, or even 3,500 in a “bear case.”

But despite Wall Street’s recent doomsday economic predictions for a recession that is “double normal length” or even “another variant of a Great Depression,” Wilson said that the economy will likely withstand rising interest rates and high inflation, or at the very least avoid a “balance sheet recession” and “systemic financial risk.”

For investors, instead, the strategist offered a chilling warning: “[P]Rice falls for stocks will be much worse than most investors expect.”

A memory of August 2008?

In his Monday note, Wilson said investors are making the same mistake they made in August 2008: underestimating the risk of falling corporate earnings.

“We bring this up because we often hear from clients that everyone knows earnings will be too high next year and therefore the market has priced it in,” he wrote, referring to the upbeat earnings forecasts. “However, we remember hearing similar things in August 2008, when the gap between our earnings model and the street consensus was just as wide.”

For some background, in mid-August 2008, the US economy was already in recession and the S&P 500 was down 20% for the year to around 1300. Many investors began to think that the worst of the bear market was over. past, but then collapsed when corporate profits plunged.

By March of the following year, the blue chip index was sitting at just 683. Wilson created a chart comparing some key stock market statistics from August 2008 to the present in his note.

In it, he pointed to the fact that the S&P 500 is still highly valued by investors today. In August 2008, it was trading at about 13 times earnings, but today it’s up to 16.8 times.

By then, the Federal Reserve had already cut interest rates by 3.25% in an effort to rescue the US economy from what would later become known as the Great Financial Crisis.

Today he plans to keep raising rates and keep them high to combat inflation. Wilson said this time “the Fed’s hands may be more tied” by high inflation, which means it is less able to bail out stocks through rate cuts if a recession strikes.

Year-on-year inflation, as measured by the consumer price index, was 5.3% in August 2008, compared with the current 7.1%.

Wilson doesn’t think stocks will fall as big as 2008 because the housing market and banking system are in a better position, but he still expects the S&P 500 to fall to new lows because of this recession.

And even if a recession is avoided, it may not be a good thing for investors.

“While some investors may take comfort in that fact as a sign that we may avoid an economic downturn next year, i.e. a ‘soft landing,’ we caution against such an outcome for equity investors because, in our view, it simply means no relief. coming from the Federal Reserve even as earnings forecasts are cut,” Wilson wrote.

Throughout 2022, many stock investors expected inflation to subside, allowing the Federal Reserve to pause its interest rate hikes or even move to rate cuts. But Wilson argues that profits will suffer as inflation wanes because US corporations were able to increase their profits by raising prices and passing on extra costs to consumers.

“Rates and inflation may have peaked, but we see this as a warning sign for profitability, a reality we believe is still underestimated but can no longer be ignored,” he wrote on Monday, adding that the “earnings outlook has worsened” in recent months.

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