Morgan Stanley expects shock 16% US profit drop to kill rally

(Bloomberg) — Morgan Stanley strategists expect a sudden decline in corporate earnings to put the brakes on a U.S. stock rally, a call at odds with Wall Street estimates.

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Instead, they are bullish on stocks in Japan, Taiwan and South Korea and recommend an overweight in developed market government bonds, including long-dated government bonds and the dollar.

Earnings per share for the S&P 500 are set to fall 16% this year, according to Morgan Stanley strategists led by Andrew Sheets. It is one of the most bearish forecasts among those tracked by Bloomberg, and contrasts with bullish forecasts from the likes of Goldman Sachs Group Inc., which expect mild growth.

“We believe the downside risk to US earnings is present,”[ads1]; Morgan Stanley analysts wrote in a note published on Sunday. “While a worsening liquidity backdrop is likely to put downward pressure on equity valuations over the next three months, we also see EPS disappointment going forward as revenue growth slows and margins shrink further.”

Morgan Stanley expects S&P 500 earnings per share to come in at $185, compared with a median forecast of $206 from strategists. Sheets’ team sees the year-end gauge at 3,900 versus Friday’s close of 4,282.37. The benchmark is on the edge of a bull market after a 19.7% rally from an October low, rising amid enthusiasm for artificial intelligence stocks despite Federal Reserve rate hikes and worries about a potential recession.

Other recommendations from the bank’s strategists include defensive stocks, investment-grade bonds in developed markets and, for yield-hungry investors, a preference for additional tier-one securities – a type of responsible bank debt – over high-yield bonds.

To be sure, some strategists are more bullish than those at Morgan Stanley. An Evercore ISI team led by Julian Emanuel raised its year-end S&P 500 target by 7.2% to 4,450. They said an easing of inflation likely signals a Fed pause and that dollars “delivered during the darkest days of the pandemic” will support the stock market.

(Updates with Chart and Views by Evercore ISI Strategists)

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