Morgan Stanley sees 16% drop in US earnings that kills stock rally

(Bloomberg) – Morgan Stanley expects a sudden decline in corporate earnings to dampen the rally in U.S. stocks, a call at odds with Wall Street estimates.

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Instead, the investment bank is bullish on equities in Japan, Taiwan and South Korea and recommends an overweight position in developed market government bonds, including long-term Treasuries, and the dollar.

S&P 500 earnings per share are expected to fall 16% this year, according to strategists led by Andrew Sheets. This is one of the most bearish forecasts among those tracked by Bloomberg, and contrasts with the bullish outlook from Goldman Sachs Group Inc., which forecasts moderate growth.

“We believe the downside risk to US earnings is now,” Morgan Stanley analysts wrote in a note released Sunday. “While a deteriorating liquidity backdrop is likely to put downward pressure on equity valuations over the next three months, we also expect EPS disappointment ahead as revenue growth slows and as margins contract further.”

Morgan Stanley expects S&P 500 earnings per share to hit $185, versus a median forecast of $206 from strategists. The Sheets team sees the year-end gauge at 3,900 versus Friday’s close at 4,282.37. The benchmark is on the verge of a bull market after a 19.7% rally from an October low, gaining amid enthusiasm for artificial intelligence stocks despite rate hikes from the Federal Reserve and worries about a possible recession.

Other recommendations from the bank’s strategists include defensive stocks, high-quality developed-market bonds and, for yield-hungry investors, a preference for additional Tier 1 securities — a type of subordinated bank debt — over bonds. high yield bonds.

(Updates with more detail on MS recommendations in paragraphs two and six.)

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