Earnings expectations for U.S. companies are “deteriorating rapidly,” according to a report from Morgan Stanley, which could exacerbate the stock market's year-to-date losses.
“Reduced earnings estimates and unexpected negative economic factors could lead to a further 5% to 10% decline in the S&P 500,” Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management, said in a note on Monday. “The U.S. now has the fastest deterioration in corporate earnings expectations of any region due to the severe 'over-earnings' of the past two years.”
U.S. stocks have tumbled this year amid high inflation, which the Federal Reserve is trying to tame by raising interest rates. The S&P 500 had fallen 16.6% this year as of Monday, and was on the verge of falling into a bear market last week.
Against a backdrop of higher interest rates and high inflation, “positive earnings news has played a key role in mitigating losses in U.S. stocks,” Shalett said.
In Shalett's view, “2022 was supposed to be a harvest year.” Following the outbreak, U.S. stocks have had “extraordinary” results in 2020 and 2021 thanks to record government stimulus. But the Federal Reserve is now tightening monetary policy to cool the economy to rein in the soaring cost of living.
The “re-pricing of stocks was driven by a reset of inflation expectations, Fed rate hikes and balance sheet reductions,” she wrote. “Profits and economic forecasts have to be adjusted, and forecasts based on the level of a V-shaped recovery in 2020-2021 are inaccurate because that level is unsustainable.”
That “revaluation” has already begun, Shalett said. She sees last week's underperformance in the retail and tech sectors “because of excess inventory, high costs and weakening price-related demand” as a case in point.
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