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Don't be fooled by bear market's 'hall of mirrors,' Morgan Stanley's Wilson warns

Published 2023-01-23, 09:53 a/m
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By Investing.com Staff

Morgan Stanley equity strategist Michael Wilson, who has made some prescient calls during the current market downturn, offered his latest macro thoughts in a note to clients over the weekend.

Wilson highlighted that the consensus view on when the U.S. economy will enter a recession has "shifted sharply" since the start of the year. Going into the year, the consensus view was calling for a tough first half followed by a strong second half. That has now shifted, with more investors now looking for a soft landing for the economy and a recession pushed out to the second half. The shift is partly related to China's reopening and the collapse in natural gas prices.

Wilson said that while these are valid viewpoints, he credits the shift in mentality to the price action in stocks, which he notes has been led by "low-quality and heavily shorted stocks." Further, there has been a strong move in cyclical stocks relative to defensive.

While Wilson calls this cyclical rotation "a powerful shift," he highlights that "bear markets have a way of fooling everyone before they're done."

"The final stages of the bear market are always the trickiest, and we have been on high alert for such head fakes, like the rally from October to December we anticipated and traded," Wilson commented. "In bear markets like last year’s, when just about everyone lost money, investors lose confidence. They start to question their processes as the price action and crosscurrents in the data create a hall of mirrors that increases their confusion. This is precisely the time to trust your own work and ignore the noise. Suffice it to say, we're not biting on this recent rally because our work and process are so convincingly bearish on earnings."

Wilson is continuing to call for further erosion in earnings, with the gap between their model and the forward estimates "as wide as it's ever been." Wilson said the last two times their model was this far below consensus, the S&P 500 fell by 34% and 49%.

"We advise investors to stay focused on fundamentals and ignore the false signals and misleading reflections in this bear market hall of mirrors," Wilson concludes.

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