Don't let the 'bear market house of mirrors' fool you, Morgan Stanley's Mike Wilson warns of the stock market - MarketWatch

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Don't let the 'bear market house of mirrors' fool you, Morgan Stanley's Mike Wilson warns of the stock market - MarketWatch

Here's why Morgan Stanley's Mike Wilson is not biting on the early year gains for stocks. It's all down to earnings that are portending bad news, he says.

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Don’t let the ‘bear market house of mirrors’ fool you, Morgan Stanley’s Mike Wilson warns of the stock market Last Updated: Jan. 23, 2023 at 10:48 a.m. ET First Published: Jan. 23, 2023 at 6:56 a.m. ET By

Barbara Kollmeyer

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Critical information for the U.S. trading day

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An important week for earnings is straight ahead, with the spotlight on updates from the tech space, which has been laying off thousands of workers.

Among those not expecting good news in the earnings pipeline is Morgan Stanley’s chief U.S. equity strategist Mike Wilson, who in our call of the day says investors need to beware of the “bear market hall of mirrors.”

A fairly upbeat start for stocks to the year — the S&P 500 SPX, +1.19% is up over 3% this year, and the beaten-down Ark Innovation ETF ARKK, +4.33% has jumped 17% — is not tempting him. “Suffice it to say, we’re not biting on this recent rally because our work and process are so convincingly bearish on earnings,” said Wilson.

He notes how the early 2023 rally has been led by “low-quality and heavily shorted stocks” and a strong shift to cyclicals versus defensives. “This cyclical rotation in particular is convincing investors that they are missing the bottom and must reposition,” he told clients in a Sunday note.

But he warns that bear markets can fool lots of investors before all is said and done, and they must keep trusting their own processes and ignore the noise. “The final stages of the bear market are always the trickiest and we have been on high alert for such head fakes, like the rally from October to December we anticipated and traded,” Wilson said.

After a “very challenging 2022, many investors are still bearish fundamentally, but question whether negative fundamentals have already been priced into stocks,” he says. “Our view has not changed as we expect the path of earnings in the U.S. to disappoint both consensus expectations and current valuations.”

One area of concern for him is that the gap between the bank’s earnings outlook and forward estimates is “as wide as it’s ever been. The last two times our model was this far below consensus the S&P 500 fell by 34% and 49%,” he said.

What Wilson expects is an “imminent” earnings recession, and with that margin erosion. That will come as costs have been rising faster than sales, and revenue has been unexpectedly slowing down for companies, he said.

And while we aren’t officially in a recession, the fallout for companies is already there — falling sales driving inventory bloat and less productive head count.

Saying all that, Wilson says they “welcome the sentiment and positioning over the past few weeks as a necessary condition for the last stage of this bear market to play out.”

The chief equity strategist, who correctly predicted the direction of the 2022 stock-market selloff, warned at the start of the year that a recession shock this year could drive another 22% drop for markets. When it comes to Wall Street’s predictions for the S&P 500 this year, Wilson is at the lower end with a call for the index to finish at 3,900.

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Stocks DJIA, +0.76% SPX, +1.19% COMP, +0.29% are higher, while Treasury bonds TMUBMUSD10Y, 3.514% TMUBMUSD02Y, 4.231% are inching up as well, and the dollar DXY, -0.25% is flat. Much of Asia is shut — China markets will be closed all week for the Lunar New Year’s holidays. The Nikkei 225 index NIK, +1.52% gained.

Bitcoin BTCUSD, +0.54% topped $23,000 over the weekend, a level it hasn’t seen since September despite last week’s Chapter 11 bankruptcy filing by Genesis Global Capital.

For more market updates plus actionable trade ideas for stocks, options and crypto, subscribe to MarketDiem by Investor’s Business Daily. And follow MarketWatch’s live blog for more market updates.

Evoquoa stock AQUA, +15.23% is up 17% after the water treatment company received a $7.5 billion offer from rival Xylem XYL, -7.95%, whose shares are down 9.2%.

Get ready for some big tech names to report this week — Microsoft MSFT, +0.98%, 3M MMM, +1.63% and Texas Instruments on Tuesday, Tesla TSLA, +7.74% and IBM IBM, +0.47% on Wednesday and Intel INTC, +3.59% on Thursday. GE GE, +2.69%, Johnson & Johnson JNJ, -0.25%, 3M MMM, +1.63%, Boeing BA, +1.55%, McDonald’s MCD, +0.26%, Visa V, -0.06%, Chevron CVX, -0.13% and AmEx AXP, +1.58% will also report.

Genius Group, the Singapore-based education technology company whose shares have soared 800% this year, has set guidance for 2023, saying it sees revenue 27% higher than 2022 and 30% higher student numbers.

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Spotify Technology SPOT, +2.07% added to a wave of tech layoffs, with the music streamer announcing plans to cut 6% of its workforce.

And: Big Tech layoffs are not as big as they appear at first glance

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“An astounding 40% of Russell 2000 companies were unprofitable last year. You have to wonder what’s going to happen to these companies in a world where higher interest rates may mean greater rationing of capital vs the freely and cheaply available flood of funding of most of the past decade,” says Callum Thomas, head of research at Topdown Charts, providing the below chart from @MichealAArouet

“Throw in a possible global recession and things could get ugly. No wonder fund managers are rotating out of U.S. equities,” he said, pointing to this Bank of America chart:

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Listen to the Best New Ideas in Money podcast with MarketWatch reporter Charles Passy and economist Stephanie Kelton.

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Barbara Kollmeyer is based in Madrid, where she leads MarketWatch's pre-markets coverage of financial markets and writes the Need to Know column. She has worked in London and Los Angeles for MarketWatch previously. Follow her on Twitter @bkollmeyer.

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