Investors are not in a bull market and an earnings recession is still set to ravage stocks, Morgan Stanley says

Investors are not in a bull market and an earnings recession is still set to ravage stocks, Morgan Stanley says
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  • Investors aren't in a bull market yet, and stocks will still be ravaged by an earnings recession, Morgan Stanley said.
  • Though investors are expecting the Fed to dial back rate hikes soon, rates could still remain high amid a tight labor market.

Investors shouldn't believe that they're witnessing the start of a new bull market, and an earnings recession is still set to be a major obstacle to any gains this year, Morgan Stanley said in a note on Monday.

"While last week's events did not lead to an immediate reversal in this latest bear market rally, we also don't think they offered any evidence to suggest a new bull market began in October," strategists said, referring to the jump in stocks last week following the Federal Open Market Committee meeting. Central bankers hiked interest rates by a softer 25-basis-points on Wednesday, spurring a brief rally as investors began to price in an end to the Fed's aggressive monetary policy.

Commentators say a pause or cut in rate hikes would be bullish for stocks, as rising interest rates weighed heavily on market in the last year.

But the headwinds haven't subsided, and rate cuts could come later than expected, the strategists warned. They note that the Fed could still keep interest rates high due to the strong labor market and strong US dollar. Those are both signs the economy could still withstand tighter conditions, and Powell has previously cited a tight labor market as a reason why the Fed needs to stay restrictive with its monetary policy.

"There really is no reason for equity investors to get excited about a cut in rates," the note said.


Additionally, forward-looking indicators of earnings per share growth in the S&P 500 turned negative last Friday, the strategists said, highlighting a major omen that an earnings recession is about to hammer the stock market. Negative earnings per share growth has only happened four times over the past 23 years, with each year being followed by a "significant" price downside in the market.

"What makes this analysis more powerful is that, historically, the majority of the price downside in equities comes after forward EPS growth goes negative. In other words, this earnings recession is not priced, in our view," the strategists said.

The bank has warned for months that investors' earnings expectations are still too high, and the market isn't fully pricing in the pain of an earnings recession, which could mirror the downturn of 2008. Stocks could fall as much as 20% in the first half of the year, according to Morgan Stanley's top stock strategist Mike Wilson, who warned investors to brace themselves for more near-term volatility.