More downside ahead as valuations are unrealistic

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

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

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

While consumer price inflation cooled to 8.5% yoy in July from 9.1% in June, Morgan Stanley said it probably hasn’t eased fast enough to justify the Fed’s continued pause that markets have already priced in.

Easing financial conditions and a strong jobs report likely further lower the chances of a dovish pivot, analysts wrote. In addition, lower earnings revisions coupled with continued higher labor costs will erode inventories.

The current market is fundamentally different from three years ago, when policymakers held a sustained pause in the Fed Funds Rate and the market recovered, analysts said, noting that business and consumer confidence is much more depressed now than in 2019.

In short, the stock market has already anticipated a sustained break from the Fed, which has a slim chance of starting,” the analyst wrote. “That development has significantly decoupled equity multiples from fundamentals, which continue to indicate that we are in a late-cyclical, slowing growth environment.”

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