Stocks At ‘High Risk’ In March, Wilson Warns

March is a “high risk” month for US equities.

That’s according to Morgan Stanley’s Mike Wilson who, after last year’s run of prophetic success, will be forgiven for having “high” confidence in his own forecasting ability.

Over the weekend, I cautioned that the re-rating which drove gains for stocks early in 2023 suggested markets are still inclined to assume a multiple consistent with a macro regime that might’ve ceased to exist in the 2020s+. That’d be perilous enough on its own. It’s perhaps doubly so when that multiple is assigned to what may end up being seen, in hindsight, as unrealistically high estimates of index-level profits.

There are a lot of implicit “ifs” in there, but then there always are. This isn’t an exact science. Wilson on Monday underscored the general tenets of my cautious assessment, warning that “the earnings recession is far from over” in the view of Morgan Stanley’s US equities team, and suggesting that the pause in profit forecast cuts doesn’t presage a pivot, to traffic in central bank clichés.

“NTM EPS estimates have started to flatten out which has provided some investor optimism [but] during bear markets NTM EPS estimates typically flatten out between quarterly earnings seasons before resuming the downtrend,” Wilson said.

I feel compelled to reiterate that even if estimates have troughed, you need to assign an 18x-19x multiple to posit any sort of upside for US equities. Some aren’t convinced that’s appropriate given the macro, policy and rates backdrop.

But setting that discussion aside, Wilson pointed out that if forward profit estimates have troughed, and the October lows on the S&P prove to be the bottom for this cycle, that’d be “the most in advance that stocks have discounted the trough in NTM EPS” going back at least 17 years.

Wilson doesn’t think estimates are done falling, though. The bank’s model suggests that won’t likely happen for another six months, which in turn points to more downside for equities.

Of course, the other factor is that unlike previous periods during with earnings estimates were falling and profit recessions loomed, inflation in the US is running triple the Fed’s target, which means no help is likely forthcoming on the monetary policy side.

“During earnings drawdowns [since 2007] the Fed’s reaction function was much different given the very different inflationary backdrop relative to today,” Wilson said Monday. “Indeed, in all of the prior troughs in NTM EPS, the Fed was already easing policy whereas today they are still tightening, possibly at an accelerating rate.”

I suppose the only thing I’d say is that the Fed wasn’t actively easing policy at the troughs in early 2016 and early 2019 as much as they were holding off on additional tightening. In the 2016 episode, the so-called “Shanghai Accord” rescued markets from the deflationary doldrums and the associated mini-panic triggered by China’s overnight yuan devaluation in August of 2015, but Fed hikes, which had only just began, eventually resumed. And although Jerome Powell’s famous U-turn in January of 2019 did ultimately presage a return to easing, it took several months, a delay Donald Trump didn’t appreciate.

In any case, none of that detracts from Wilson’s overarching point, which is just that estimates probably haven’t troughed, stocks likely haven’t bottomed and the Fed surely isn’t done tightening.