A growing number of Wall Street firms and strategists are turning bearish on the financial markets amid the sharp selloff in stocks.
For the stock market bears who anticipated a correction, they’re claiming victory after the leading benchmark indexes have plummeted over the last week.
Writing in a Jan. 24 research note, analysts at Morgan Stanley, including Michael Wilson, warned that “winter is here.”
With the Federal Reserve tightening monetary policy and economic data becoming worrisome, Wilson stated that the stock market rout “fits nicely” into his calls.
Have stocks reached a bottom, or is there still more shedding to go?
“We have been monitoring PMIs and earnings revisions breadth for signs the slowdown is bottoming, but it has quite a bit further to go, in our view, and equity markets are not yet priced for it,” the Morgan Stanley strategists stated. “It’s too early to get bullish.”
IHS Markit composite purchasing managers’ index (PMI) plunged to 50.8 in January, down from 57 in December 2021. The manufacturing PMI fell to 55, down from 57.7, while the services PMI declined to 50.9, down from 57.6.
Kristina Hooper, chief global market strategist at Invesco, says the odds of a sharp market downturn this year are intensifying. The Federal Reserve hiking interest rates and shrinking its more than $8 trillion balance sheet could further increase pressure on the ongoing correction.
“We also believe more policy tightening is likely given the Fed’s hawkish pivot. However, we do not believe it will be so excessive as to end the economic cycle; rather, we continue to expect a measured deceleration in growth for the U.S. and other developed countries where fiscal and monetary stimulus is being removed. There is always the risk of a policy error, but it is not our base case,” she wrote.
According to the CME FedWatch Tool, the market is penciling in a 25-basis-point rate hike at the March Federal Open Market Committee (FOMC) policy meeting.
The FOMC will complete its two-day meeting this week. The Fed could provide insight into how it will guide monetary policy in the coming months and its economic and inflation forecasts.
Other financial institutions purport that the earnings season has facilitated an escalation in pessimism among analysts and investors.
Goldman Sachs stated that the guidance for the upcoming months has been “disappointing.” In a recent note, Goldman strategists, led by David Kostin, said that only one company listed on the S&P 500 has beaten earnings estimates and improved its outlook: Micron Technology. Overall, five out of the six companies that offered first-quarter guidance have reduced expectations.
With the U.S. central bank unwinding its pandemic-era stimulus and relief efforts, market analysts believe earnings growth could take a serious hit.
“Disappointing guidance. Investors are most interested in forward-looking guidance from managements, and recent information on that front has been concerning,” strategists wrote. “Investors will require a catalyst in the near-term to add length, but few obvious catalysts are evident in the near-term.”
Before calling a bottom, Goldman Sachs is monitoring several factors moving forward.
Money market outflows totaled $84 billion last week, with strategists determining whether the capital is being allocated to trading accounts. Institutional investor sentiment is at a decade low. Leverage remains elevated, and this could prevent traders from buying the dip. Retail investor outflows have been rising, with volumes on their go-to indexes and stocks subsiding.
The R Word
Is the market beginning to think a recession is on the horizon? Jefferies thinks so.
“We think the market is now thinking the R word. Why else would the Russell 2000 be down as much as it has been?” Steven DeSanctis, a strategist at Jefferies, wrote in a note. “Investors see an aggressive Fed pushing the U.S. economy into a big slowdown or even a recession over the next year.”
JPMorgan chief global strategist David Kelly is forecasting the possibility of a U.S. recession in the next few years. Although it isn’t the institution’s baseline scenario, he does believe that “investors should diversify not because of what they expect but because of what they never expect that ends up biting them.”
Kelly noted that it would be challenging for speculative investments, such as growth stocks and cryptocurrencies, to rally in a rising-rate environment.
Cathie Wood, head of Ark Investor, warned about a possible recession and a significant slowdown in China.
“During the next three to six months the market is likely to focus more on the risk of recession in the US, the serious slowdown in the Chinese and emerging market economies, and potentially a surprising drop in inflation,” Wood stated in her fund’s quarterly report (pdf) and letter to investors.
Still, global fund managers remain optimistic on stocks and the broader economy, a recent Bank of America survey found.
The monthly poll revealed that institutional investors are betting on commodities and stocks, although the market is engaging in a rotation, transitioning from growth to value and tech to banks.
This contradicts the bank’s strategists, who have been projecting a correction in equity markets.
“We remain stagflationary bears,” the strategists said.
Just 7 percent of the investors polled think a recession will occur in the next 12 months.
At the opening bell on Jan. 25, the Dow Jones Industrial Average, S&P 500, and Nasdaq Composite Index added to their double-digit year-to-date losses. Gold and crude oil prices rose, while Bitcoin and Ethereum extended their slide.
For a financial market that became accustomed to the Federal Reserve’s liquidity injections, investors have been blindsided by the events unfolding, Mark Cabana, head of U.S. short rate strategy at Bank of America, told CNBC.