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The S & P 500 may have quite a bit further to fall this year, especially if the U.S. is pushed into a recession, according to Morgan Stanley. Right now, the 2023 consensus for the stock market is that the S & P 500 will fall in the first half, reaching somewhere between 3,500 to 3,600 in a mild recession, then rally in the second half of the year. This consensus is likely wrong, points out strategist Mike Wilson, who thinks that stocks could fall another 23% or more from current levels, putting the S & P 500 near 3,000. His forecast is much lower than the consensus on the Street and CNBC’s own strategist survey. “The bottom line, we don’t think a 3,500-3,600 S & P 500 is consistent with the consensus view for a mild recession,” Wilson, who was one of the few strategists on Wall Street to correctly call 2022’s dismal stock performance, wrote in a Monday note. “That is one way the consensus could be right directionally, but wrong in terms of magnitude.” The concern is that most investors are assuming that “everyone is bearish,” meaning that any price downside in a recession will be mild. What Wilson sees in stocks in 2023 Wilson has a few reasons to again go against the grain. “First, we recall similar views in August 2001 and 2008 immediately before the recession hit in earnest and the bottom dropped out on valuations,” he said. “Second, valuations are not cheap at current prices, and a Fed pause will likely not lead to higher P/Es if growth is really rolling over.” He sees the equity risk premium of the S & P 500 – currently around 2.33% –too low given the earnings risk forecast. In 2008, the equity risk premium reached 7%, a level not unthinkable if another financial disaster were to occur. This year, an equity risk premium of about 4% is probably more likely, and Wilson thinks the figure will rise another 2% to 2.5% from current levels. “Third, recessions are usually accompanied by unforeseen shocks/events that cause valuations to overshoot to the downside,” he said. Wilson also sees earnings performing worse than most on Wall Street are anticipating. “Our base case forecast for 2023 S & P 500 EPS is $195 while our bear case forecast (a recession) is $180,” he said. “This compares to the bottoms up consensus forecast of $230, which nearly every client agrees is too high.” The main reason for this outlook is negative operating leverage, which has already hit some companies as they try to bounce back from the pandemic and deal with a swiftly changing economic environment. As inflation cools, this might become more of an issue, as high price changes boost operating leverage. What’s next Wilson sees price dispersion picking up over the next few weeks due to the widening relative performance gap between companies who are operationally efficient and those that aren’t. “In this sense, we think companies that minimize capex, inventory and labor investment and maximize cash flow will be rewarded on a relative basis,” he said. — CNBC’s Michael Bloom contributed to this report.
The S&P could fall another 23% in a recession, surprising investors
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