Expensive US equities are flashing a major warning sign that could see the S&P 500 sliding as much as 26% in the first half of this year, according to Morgan Stanley strategists.
Recent economic data suggested that the economy might be able to dodge a recession, but that has also taken the possibility of a US Federal Reserve (Fed) pivot off the table, according to a team led by Michael Wilson — ranked No 1 in last year’s Institutional Investor survey when he correctly predicted the sell-off in stocks. That’s left rates higher across the curve and stocks more expensive than at any time since 2007 by the measure of equity risk premium, they added.
Equity risk premium has entered a level known as the “death zone”, making risk-reward very poor especially, as the Fed is far from ending its monetary tightening and earnings expectations remain 10% to 20% too high, Wilson said. “It’s time to head back to the base camp before the next guide down in earnings,” he wrote in a note on Monday (Feb 20).
The strategists hold a view that the S&P 500 can slide to as low as 3,000 — a 26% drop from its most recent close — in the first half of 2023. That’s “very much out of consensus at this point”, especially as active institutional and retail investors are more bullish than they have been in over a year, they said.
