‘Winter Is Here,’ Stocks Can Fall 10%, One Bank Warns

It’s natural that market participants are obsessed with the Fed, but it’s time to worry about growth.

That was one message from Morgan Stanley’s Mike Wilson, who on Monday suggested equities aren’t currently priced for what he sees as a likely further deceleration in economic activity.

“It’s just a matter of how icy it’s going to get,” he wrote, postulating that even if things don’t get any colder, “current temperatures” may mean equity benchmarks have an additional 10% to fall. Whatever the case, it’s “too early to get bullish,” in the bank’s opinion.

Signs of economic weakness have proliferated of late. Retail sales crumbled in December and consumer sentiment is laboring beneath the weight of the highest inflation in 40 years in the US (figures below).

Many Americans, meanwhile, aren’t “laboring” at all, and that means intense competition for scarce workers and steady upward pressure on wages, albeit not enough to offset rising consumer prices.

“As we’ve been writing for months, we view the current deceleration in growth as more about the natural ebbing of the cycle than the latest variant of COVD,” Wilson said. He suggested Omicron may mark the end of the pandemic, but the implication for markets is “the end of extraordinary stimulus, both monetary and fiscal.”

From there, he raised an interesting question about supply chains and what we may discover once things normalize. While the resolution of disruptions which have bedeviled the economy will likely bring down inflation, they “may also reveal the degree to which demand has been supported and overstated by double ordering,” Wilson wrote, adding that “weaker PMIs are leading stocks and there is still meaningful downside, in our view.”

The figure (below) is simple enough to reproduce, but Wilson’s annotations are useful to the extent they spell out what receding PMIs may entail for equities.

Morgan’s economists see ISM manufacturing decelerating to 54.8 in January. The bank on Monday cited last week’s disastrous read on the Empire gauge, which I called a potential “canary.”

Wilson drew a parallel with the 1940s. “The end of World War II freed pent-up savings and unleashed demand into an economy unable to supply it,” he said, noting that “double-digit inflation ensued, which led to the first front end rate rise in over a decade and the beginning of the end of financial repression.” He then asked if that “sounds familiar?”

The read-through is straightforward enough. For Wilson, secular stagnation has run its course and the pandemic-inspired inflation flareup forced the end of financial repression. The road out “won’t be smooth,” though, and investors should “hunker down for a few more months of winter as slowing growth overtakes the Fed as the primary concern.”