By Senad Karaahmetovic
Reflecting on the last week and especially a big selloff in stocks on Friday in response to Fed Powell’s speech, Morgan Stanley’s Michael Wilson argues that the largest risk for equities remains earnings, not rates.
Although Powell was clear in his message that the Fed is fully focused on bringing inflation down, which should result in higher rates, Wilson still believes that “the path for stocks from here will be determined by earnings, where we still see material downside.”
“While P/Es have come back down, they remain well above fair value based on our equity risk premium framework,” Morgan Stanley’s top U.S. equity strategist wrote in a client note.
While the Fed was to blame for “almost all of the weakness” in the first half of the year, Wilson reiterates that the second half of the year will be marked by earnings expectations for next year.
“Equity investors should be laser focused on this risk, not the Fed, particularly as we enter the seasonally weakest time of the year for earnings revisions, and inflation further eats into margins and demand,” Wilson added.
Morgan Stanley’s leading earnings model sees “a steep fall in EPS growth over the next several months.”
“A key input to this model is the ISM manufacturing PMI, and leading regional Fed manufacturing surveys point to continued downside in the ISM PMI. The rate of change on earnings revisions breadth also leads forward EPS growth and points to growth downside as well,” the Morgan Stanley strategist concluded.