Investors, with the S&P 500 tumbling 19% as the Federal Reserve cranked interest rates higher to smother inflation. But 2023 may offer up more misery, with a looming recession providing another dose of risk, according to Morgan Stanley chief U.S. equity strategist Michael Wilson.
The S&P 500 could fall to as low as 3,000 points, a decline of more than 20% from its current trading level of roughly 3,900 points, Wilson said in a YouTube discussion last month about his 2023 outlook. The main reason for that bearish forecast: U.S. corporate profits are likely to slump as the economy slows and perhaps enters a recession.
Such a steep decline in stocks would likely result in trillions of additional losses on top of last year’s hit to household wealth, impacting millions of workers who are saving for retirement as well as investment funds for pensions, universities and other institutions.
Wilson, who was named the top investment strategist by Institutional Investor last year, said he expects S&P 500 companies to be less profitable in 2023 than many other forecasters believe. If he’s right, that could put more pressure on stocks because investors generally pay less for companies when their profits erode.
“We often hear from clients that everyone knows earnings [estimates] are too high next year and therefore the market has priced it,” Wilson said. “We recall hearing similar things in August of 2008 — the last time the spread between our earnings model and the street consensus was this wide.”
That may cause more than a twinge of concern for investors given that 2008 marked the start of the Great Recession. The S&P 500 plunged about 37% that year, although the index regained its footing in 2009, when returns jumped by double-digits, and continued to rise for the rest of the decade.
“The good news is we don’t expect a balance sheet recession next year or systemic financial risk,” Wilson added. “But the earnings recession could be similar to what transpired in 2008 and 2009.”
Wilson noted that his forecast pegs the average per-share earnings of S&P 500 companies at $195 in 2023, far below Wall Street’s forecasts of about $215 to as high as $231 per share.
“Don’t assume the market prices this negative of an earnings outcome until it happens,” Wilson noted. “If our earnings forecast proves to be correct, the price declines for equities will be much worse than what most investors are expecting.”
Wall Street outlook
Morgan Stanley isn’t alone in forecasting the market will tumble in 2023, with several other Wall Street firmsbefore rebounding by year-end.
The market could slip another 8% before hitting bottom, according to Comerica Wealth Management. JPMorgan forecasts the market will “re-test” the lows of 2022 — about 3,500 — in the first half of 2023.
“The S&P 500 still screens as statistically expensive vs. history on 17 out of 20 of the measures we track,” Bank of America analysts noted in a January 9 report.
Yet some investment firms predict the market will rebound later in the year, such as JPMorgan’s forecast that the S&P 500 will rise 8% by the end of 2023 from its current levels.
Underlying economic issues are an overhang for U.S. corporations and the financial health of American households, according to strategists.
With inflation still running high, the Federal Reserve is expected to continue with its regime of interest rate hikes in 2023 — which could dip the U.S. into a recession this year, wrote Maria Vassalou, co-chief investment officer for multi-asset solutions at Goldman Sachs Asset Management, in a report last week.
“What’s more, we do not expect the Fed to cut rates in the year ahead, as the U.S. downturn is likely to be relatively shallow,” she wrote, adding, “Investment conditions will remain challenging.”