Morgan Stanley’s Wilson says the S&P 500 could fall 26% in months

(Bloomberg) – According to strategists at Morgan Stanley, expensive U.S. stocks are a key warning sign that the S&P 500 could fall as much as 26% in the first half of this year.

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Recent economic data suggests the economy may be able to dodge a recession, but that’s also taken the possibility of a Federal Reserve reversal off the table, according to a team led by Michael Wilson — ranked No. 1 in the last year’s Institutional Investor survey he correctly predicted the stock sell-off. This leaves interest rates higher across the curve and equities more expensive than at any time since 2007, as measured by the equity risk premium, they added.

The equity risk premium has reached levels known as the “death zone,” making the risk/reward trade-off very poor, especially as the Fed is far from completing its policy tightening and earnings expectations are 10% to 20% too high stay, Wilson said. “It’s time to return to base camp before the next earnings drop,” he wrote in a note Monday.

Strategists believe the S&P 500 could fall as low as 3,000 points in the first half of 2023 — a 26% drop from its last close. That’s “very divided at this point,” particularly as an active institution, and retail investors are more optimistic than they have been for over a year, they said.

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