Morgan Stanley Predicts Lower Profits to Impact Economy-Linked Stocks Amid Inflation Concerns

Morgan Stanley's Michael Wilson forecasts a decline in US corporate earnings, predicting a downturn for stocks tied to the economy. Concerns over falling inflation and its impact on pricing power drive investor apprehension, potentially hindering cyclical sectors.

Morgan Stanley's Michael Wilson Warns of Declining Earnings Impacting Economy-Linked Stocks Amid Inflation Concerns

Michael Wilson of Morgan Stanley predicts that a bleaker outlook for US corporate earnings will decrease equities linked to the economy. The prospective impact of declining inflation on pricing power is a source of concern for investors, according to Bloomberg.

As one of the most bearish voices on US equities last year, the strategist brings a wealth of experience and insight. He stated that a metric that measures the ratio of profit upgrades to downgrades has weakened, as is customary for this time of year. So-called cyclical sectors are primarily driving this.

“In our view, this does not offer support for a broad cyclical rotation,” Wilson said, adding that the market was “also potentially focused on the notion that falling inflation may prove to be a headwind for cyclicals, which are highly dependent on pricing power.”

The rally in US equities has been impeded since the benchmark S&P 500 index reached a record high in mid-July amid apprehensions that a slowing economy will prompt the Federal Reserve to reduce interest rates more rapidly and significantly than anticipated. According to swaps data, markets are currently pricing a rate reduction by September.

Citigroup Reports Surge in Earnings Downgrades, Defensive Sectors Outperform Cyclicals in S&P 500

Since late June, Citigroup's earnings aggregate indicates that downgrades have significantly outnumbered upgrades. Since April, the relatively safer defensive sectors have outperformed the cyclical equities in the S&P 500.

The recent sell-off has also impacted the most significant technology stocks, as investors have favored smaller, more affordable equities. According to Wilson of Morgan Stanley, he continued to endorse large-cap equities “though we are watching the fundamental and technical backdrop for small caps closely.”

“For now, we continue to think the better risk/reward within small caps is growth equities, which should benefit from a cost of capital standpoint as the Fed cuts (rates),” Wilson said.

Lori Calvasina, a strategist at RBC Capital Markets, also stated that the current earnings revision trends do not yet indicate a further rotation in market leadership.

“Despite the challenging news flow from the first few mega-cap growth names that were reported,” Calvasina noted that profit estimates for the ten most extensive S&P 500 stocks are being raised by a sharper degree than the rest of the index. “We’ve still not seen a clear shift in favour of small caps yet.”