Equities have proven remarkably resilient in the face of recent banking sector tumult and amid ongoing uncertainty about the outlook for inflation.

The read-through of pervasive macro ambiguity for monetary policy is that although developed market central banks are set for a coordinated pause, rates may need to stay higher for a longer period.

That doesn’t preclude cuts to fight any downturn that shows up in the months ahead. It just means that a return to the lower-bound isn’t especially likely, and future iterations of QE may be designed more narrowly — tailored to ensure governments can borrow at low rates to finance military spending and domestic social agendas, for example, as opposed to being implemented with the explicit aim of underwriting carry trades and encouraging investors to be levered long financial assets.

That alone should be cause for concern among equity investors. When you factor in the potential for a deeper-than-expected decline in profits as so-called “Greedflation” runs out of runway both due to waning pricing power and political pressure, it’s not difficult to make the bear case. Just ask Morgan Stanley’s Mike Wilson, Wall Street’s most famous bear, and last year’s top-ranked, top-down strategist.

In a new note, Wilson reiterated his long-standing contention that earnings estimates remain far too optimistic, even as bottom-up consensus did finally get around to collectively predicting a shallow earnings recession.

As a quick reminder, EPS growth is expected to be negative again this quarter and also next quarter, before ultimately inflecting. Although the expected ~7% YoY drop for Q1 profits would be the largest since 2020, the forecasted peak-to-trough decline for index-level EPS would amount to a mere blip that looks nothing like the earnings declines seen during the last three recessions. That’s what has some strategists skeptical+.

On Monday, Wilson channeled another Mike: Mike Campbell, from The Sun Also Rises. “‘Gradually, then suddenly’ is a good description of the recent bank failures,” Wilson wrote, referencing the character’s famous, three-word account of the “two ways” he went bankrupt.

Wilson used Hemingway to contextualize SVB. “The losses from long-duration Treasury holdings and concentrated deposit risk built up gradually over the past year, and then suddenly accelerated, leading to surprising failures,” he recounted. “In hindsight, these failures seem predictable given the speed and magnitude of the Fed’s rate hikes, some regrettable regulatory treatment of bank assets and concentrated deposits from corporates [but] most did not see the failures coming, which raises the question of what other surprises may be coming from the most abrupt monetary policy adjustment in history?”

But that’s not the only literary parallel. “The analogy with Hemingway’s poetic passage can extend to the earnings growth deterioration observed over the past year,” Wilson wrote. “Until now, the decline in earnings estimates for the S&P 500 has been steady and gradual.”

Although it’s hard to make out, the annotations on the left-hand chart are “gradually” and “suddenly.” The second “suddenly” is accompanied by a pair of question marks.

So far, forward profit estimates have declined by just ~6%. That’s not enough, according to Morgan Stanley’s US equities team. The bank’s non-PMI leading earnings indicator (which I mention frequently) remains totally disconnected from consensus.

“If we are right on our well below-consensus NTM EPS forecast, the pace of decline in these estimates should increase materially over the next few months/quarters as revenue growth begins to disappoint,” Wilson warned.

He went on to recap the basic underlying thesis behind Morgan Stanley’s cautious house view, which centers on the contention that top-line growth is inflated by red-hot nominal GDP, inflation and pricing power. Those tailwinds have helped offset the drag from higher costs. In fact, they’ve more than offset it, hence record profit margins (i.e., “Greedflation”). If the tailwinds abate, margins will compress, and so, naturally, will earnings.

“We would caution those cheering the softer-than-expected inflation data last week,” Wilson said, adding that,

Falling inflation, especially for goods, is a sign of waning demand, and inflation is the one thing holding up revenue growth for many businesses. The gradually eroding margins to date have been mostly a function of bloated cost structures. If/when revenues begin to disappoint, that margin degradation can be much more sudden, and that’s when the market can suddenly get in front of the earnings decline we are forecasting.

Nobody ever lives their life all the way up except bullfighters.