That’s the verdict from strategists at Morgan Stanley and Goldman Sachs, who each warned as a new week kicked off that the stock market wasn’t fully pricing in a recession. And that’s as U.S. equities SPX, +2.45% were off to a solid start as trading resumed after Monday’s Juneteenth holiday.
“With our view for lower multiples and earnings now more consensus, the markets are more fairly priced. However, it does not price the risk of a recession, in our view, which is 15-20% lower, or roughly 3000,” said Mike Wilson, Morgan Stanley’s chief U.S. equity strategist and one of most bearish voices on Wall Street this year, in a note Tuesday. “The Bear market will not be over until recession arrives or the risk of one is extinguished.”
Wilson sees much of Wall Street still assuming much higher price-to-earnings ratios for year-end S&P 500 target prices. His bank was “very out of consensus” coming into 2022 with a forecast for a 20%-plus fall in valuations — they’re now down 28% year-to-date. But Morgan Stanley MS, +2.37% analysts have kept dropping their valuation call as bond yields rise, with the current 15.3 P/E ratio incorporating an equity risk premium (ERP) of 330 basis points, too low in his opinion.
Wilson would like to see the ERP at 370 basis points, which would leave the S&P 500’s P/E ratio falling to 14 times, as long as bond yields TMUBMUSD10Y, 3.228% and earnings estimates are stable. ERP represents the extra return investors expect on riskier stocks over risk-free bonds.
Echoing some of Wilson’s thoughts was Goldman Sachs’s chief global equity strategist, Peter Oppenheimer, who sees the market pricing in the risk of just a mild recession, rather than an average or deep contraction. He sees the current bear market as a cyclical one, and a function of the economic cycle, according to a Goldman Sachs GS, +1.79% research note Tuesday.
“Most bear markets end when economic conditions are still poor, but there is a sense that they are no longer deteriorating at the same rate,” Oppenheimer told clients in the note. “Even if eventually yields do not rise a lot further, it seems likely that the markets would at least price the risk that they will before we can see a genuine recovery.”
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