Morgan Stanley Is Skeptical about the S&P 500’s Upside

• Morgan Stanley doesn’t believe the S&P 500’s current breakout above 3,000 will last.
• The bank also doesn’t expect Fed rate cuts to rekindle growth.

So far this year, the performance of the US stock markets has been outstanding. All three benchmark stock indexes have reached new highs. Year-to-date, the S&P 500 (SPY), the Dow Jones Industrial Average (DIA), and the Nasdaq Composite (QQQ) have risen 20.8%, 16.6%, and 26.6%, respectively.

Despite this marvelous performance, there’s one investment bank that isn’t positive on the future outlook of the markets. As reported by CNBC, Morgan Stanley’s (MS) chief US equity strategist, Mike Wilson, wrote in a note to clients on July 29 that he doesn’t expect the S&P 500 to get much of a boost from the Fed’s rate cut. He said, “While our 2400–3000 call from 18 months ago may look vulnerable, we think this latest surge will fail again, as we don’t expect a Fed cut to rekindle growth the way market participants may be hoping, and now pricing.”

We highlighted in Morgan Stanley Is Concerned about an Earnings Recession that Wilson expects the S&P 500 to trade in the range of 2,400–3,000, as he deems the market a “rolling bear market.” Though he made this prediction at the beginning of April and the markets have gained significantly since then, he stands by his call.

As CNBC reported, Wilson said, “While our 2400–3000 call from 18 months ago may look vulnerable, we think this latest surge will fail again, as we don’t expect a Fed cut to rekindle growth the way market participants may be hoping, and now pricing.”

The Fed is holding its two-day meeting starting on July 30 and is widely expected to cut rates by at least 25 basis points. Easing expectations from the Fed have been one of the major factors driving the markets in the last few months. However, MS believes that it won’t be a significant catalyst going forward, as most of the rate cut has been priced into the markets.

Moreover, Wilson believes that because of the trade war between the US and China and the Fed’s pivot, interest rate expectations have fallen. This has made equities look attractive, though they’re really not. Wilson doesn’t think the fundamentals of US stocks are strong.

MS isn’t alone in believing that the Fed rate cut won’t do much for the markets. You can read Goldman Sachs Doesn’t Think a Fed Rate Cut Will Boost Stocks and Why JPM’s Chief Global Strategist Says a Rate Cut Won’t Help for more on this topic.

Wilson also talked about the S&P 500’s attempts to break past the psychologically important 3,000 level. He said that in the last 18 months, the S&P 500 has peaked close to or above the 3,000 range three times. Wilson argues that last two times it did so, a correction followed, and he thinks this time it’ll be the same. He said, “Big disappointments in capital spending and business surveys suggest growth could slow further in 2H.”

Wilson is also less sanguine about the earnings forecasts for companies. He believes that even after the drop in earnings forecasts since the start of the year, they remain “materially too high for the second half of 2019 and 2020.” JPMorgan Chase has also warned about a market crash in the third quarter driven by downward revisions to earnings forecasts for the next year.

Therefore, due to the expectations of a combination of disappointment from earnings and economic growth, Morgan Stanley remains pessimistic regarding the future of the markets.

This expectation isn’t hard to see when we look at the recent earnings releases from US companies. While a large number of companies have achieved earnings beats, the associated rhetoric hasn’t been positive. Caterpillar attributed a part of its disappointing earnings to lower demand from China amid the ongoing trade war. Boeing (BA) also disappointed the markets with a record loss of $2.9 billion in the second quarter. Honeywell International said it is taking a cautious approach due to macro signals, including trade tensions, the US-China trade war, and Brexit. CNBC reported on July 20 that out of the S&P 500 companies that had reported their earnings, one-third had cited the US-China trade war as a headwind to profits.

In Why Morgan Stanley downgraded global equities, we discussed how Morgan Stanley downgraded global equities from “equal-weight” to “underweight” on July 7, mainly because the bank expects poor returns from equities over the next 12 months.