(Bloomberg) — A rally in stock markets may prove to be short-lived as inflation pressures remain high and a recession seems increasingly likely, according to strategists at Morgan Stanley and Goldman Sachs Group Inc.
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While the slump in equities since the beginning of the year reflects investor expectations of a contraction in growth, “I don’t think a deep recession is being priced yet,” said Peter Oppenheimer, chief global equity strategist at Goldman Sachs. “It’s premature to believe inflation is going to come down quickly or the pressure has eased for the Federal Reserve and other central banks to tighten,” he said on Bloomberg TV.
For Morgan Stanley’s Michael J. Wilson, the odds of a US recession continue to increase, with the broker’s model showing a 36% probability in the next 12 months, while other warnings include rising jobless claims and falling job openings. “Counter-trend rally may continue, but make no mistake, we don’t believe this bear market is over, even if we avoid a recession,” he wrote in a note on Monday.
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Wall Street’s top strategists are urging caution as US and European stock markets rally amid bets that the Fed won’t deliver an outsized rate hike at its meeting next week, and as fresh data showed a bigger-than-expected decline in US consumers’ long-term inflation expectations.
But Oppenheimer warned that even if the headline inflation figure starts to come down, it’s too soon to expect that consumer prices would follow suit quickly.
With the macroeconomic outlook remaining gloomy, investors are turning to the corporate earnings season to see if margins have been resilient to the surge in prices and glum sentiment.
JPMorgan Chase & Co. strategists say that markets could look through more challenging earnings-related newsflow over the summer. Stocks generally tend to peak at or ahead of the earnings trough, strategists led by Mislav Matejka wrote in a note on Monday, adding that the market could be nearing a point where bad data start to be seen as good news.
But Morgan Stanley’s Wilson, who has been one of the staunchest equity bears this year and who correctly predicted the latest selloff, said he was “skeptical” about expectations that margin pressures would ease beyond the second quarter.
“The combination of continued labor, raw material, inventory and transport cost pressures coupled with decelerating demand poses a risk to margins that is not reflected in consensus estimates,” Wilson said, adding that even if estimates for revenue growth remain static, a return to pre-Covid net margin levels implied a 10% hit to forward earnings-per-share.
Goldman Sachs strategist David J. Kostin said in a note on July 15 that he expects the weak macroeconomic outlook to threaten companies’ profitability, which has already receded from record highs. Margins and borrowing costs are now two key risks for stocks’ return-on-equity, which held up in the past year despite rising input costs, omicron and supply chain disruptions, he said.
But in the meantime, Goldman’s Oppenheimer is more bullish about the next 12 months for equity markets. “Keep in mind bear markets nearly always trough when you’re in a recession and data is bad and earnings are still being revised down,” he said on Bloomberg TV, adding that cyclical stocks and technology are likely to lead the rally once equities show a meaningful recovery.
(Updates with comments from Goldman Sachs from first paragraph)
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