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Stocks heading for ‘boom-bust’ breakdown as falling inflation leads to earnings recession, Morgan Stanley CIO says

Bloomberg TV

  • Equities are still heading for a sharp earnings recession, said Morgan Stanley’s Mike Wilson.

  • The chief investment officer and equity strategist pointed to falling inflation hurting corporate earnings.

  • Corporate earnings could fall by as much as 16%, strategists previously warned.

Stocks are still heading for a sharp earnings recession as falling inflation chokes corporate earnings, Morgan Stanley chief investment officer Mike Wilson warned in a new note to clients.

Wilson, who has been sounding the alarm for months for an earnings recession, reiterated his view that the market is in the middle of a boom-bust cycle. That’s because the expansionary fiscal policies of the pandemic drove up inflation and asset prices (the boom), and the tight monetary policies put in place over the past year to control inflation have weighed on asset prices (the bust), with the S&P 500 down 20% in 2022.

But for now, the market appears to be shaking off boom-bust risks as more investors plunge into stocks as inflation cools and the economy remains strong.

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That strength is largely due to robust fiscal spending, which allowed the economy to grow faster than expected this year, Wilson said. But investors still have cause for concern as fiscal spending could ease and falling inflation could soon hurt corporate earnings.

“We think the even bigger takeaway for investors is to consider that if fiscal spending needs to be curtailed because of high political or financing costs, the unfinished profit slump that started last year should continue to fall, as inflation will not stop at 2 percent.” Wilson and his team of strategists said in a note Monday. “Our boom/bust framework would suggest inflation when it comes to co-op revenue (i.e., prices fall to zero or even below).”

Falling inflation is already starting to hurt revenue and profit growth, according to leading indicators. The Producer Price Index, which the bank calls its “favorite leading indicator” of inflation relative to corporate earnings, has fallen rapidly over the past year, with final asking prices rising just 0.1% in June.

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The Congressional Budget Office has also forecast that government spending will slow this year, with the estimate for annual discretionary spending falling $29 billion from its previous estimate in February.

“If fiscal spending starts to be curtailed, as the CBO predicts, these deflationary pressures on companies will likely be reflected in revenue growth, which would call into question the accelerating growth narrative,” Wilson’s team added.

Corporate earnings could fall by as much as 16%, strategists previously warned.

Wilson is one of the most bearish voices on Wall Street right now, as other forecasters have pointed to the resilient economy supporting the stock rally. The S&P 500 could be another secular bull market, RBC said in a recent note, which predicts the benchmark index will triple to 14,000 by 2034.

Read the original article on Business Insider

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