Stocks Have Sniffed Out the Bad News and the S&P 500 Could Be Headed Lower as…

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Morgan Stanley equity strategist Michael Wilson, who has been correctly bearish during the recent market drawdown, highlights that negative data points are piling up. They tend to follow stocks, which have been signaling that bad news is coming for months. Further, Wilson highlights that the real earnings yield is the most negative since the 1950s amid the current high inflation rate.

Illustrating that stocks usually know the news ahead of time, Wilson notes that stocks sniffed out the Fed’s aggressive pivot on policy in January, which was witnessed in the sell-off in high multiple stocks in November and December. He said now they are figuring out that the first quarter may be the last good quarter of earnings “as higher costs and increased recession risks weigh on future growth.”

On the negative real earnings yield, Wilson notes stocks no longer provide the inflation hedge many investors are counting given the rapid rise in inflation. He notes real earnings yield tends to lead real stock returns on a y/y basis by about six months. “It suggests we have meaningful downside at the index level as investors figure this out,” he comments. “We think the S&P 500 has minimum downside to 3800 in the near term and possible as low as 3460, the 200-week moving average if forward 12 month EPS start to fall on margin and/or recession concerns.”

Wilson continues to think earnings estimates remain too high over the next 12 months and said there is growing evidence that growth is slowing faster than most investors believe. The strategist said Amazon (NASDAQ:) CEO Andy Jassy’s comments on the earnings call last week might encapsulate this view better than anything else:

“Today, as we’re no longer chasing physical or staffing capacity, our teams are squarely focused on improving productivity and cost efficiencies throughout our fulfillment network. We know how to do this and have done it before. This may take some time, particularly as we work through ongoing inflationary and supply chain pressures, but we see encouraging progress on a number of customer experience dimensions, including delivery speed performance as we’re now approaching levels not seen since the months immediately preceding the pandemic in early 2020.”

Overall, Wilson said that S&P 500 has a minimum downside to 3800 (-8%) in the near term. However, true technical support lies at the 200-week moving average, which is 3460, or -16%. However, on the positive side, Wilson said the market is currently so oversold that any good news could lead to a vicious bear market rally.