Mike Wilson, the chief investment officer at Morgan Stanley, was the No. 1-ranked portfolio strategist on Wall Street last year. As many analysts remained bullish on the market exiting 2021, Wilson warned that rising interest rates and slower economic growth would lead to a tough year, and boy was he right. The broader benchmark S&P 500 index fell more than 18% in 2022.
Recently, Wilson made another big call that investors may want to pay attention to.
The stock market could drop 26%
Wilson recently said that he doesn’t think the strong market run at the beginning of the year will last and that he expects the S&P 500 to fall 26% from the 4,080 level it hovering at when Wilson made the call. That would put the S&P 500 around 3,000, a level it hasn’t touched since the middle of 2020 when the pandemic had just started.
Wilson said he believes the market has found itself in a “death zone,” an expression used to describe the area just beneath the peaks of some of the world’s largest mountains where climbers start to run out of oxygen. “The bear market rally that began in October from reasonable prices and low expectations has morphed into a speculative frenzy based on a Fed pause/pivot that isn’t coming,” Wilson wrote in a recent research note.
Many analysts, banks, and economists have projected that the Federal Reserve will cut interest rates later this year based on the belief that the Fed’s intense interest rate-hiking campaign may end up tipping the economy into a recession. While inflation has seemingly started to subside, parts of the economy such as the labor market and shelter costs are still running hot and may make it difficult for the Fed to stop raising rates or to cut them.
For instance, the U.S. economy added more than half a million jobs in January, and the Fed has said multiple times in the past that it needs to see deterioration in the labor market to know it’s won the war against inflation. Furthermore, housing costs have remained high and accounted for nearly half of the Consumer Price Index’s rise in January.
Housing is typically a big monthly expense for consumers, so it can lead to persistent inflation on its own — and Wilson believes that inflation is going to remain stickier than many people think.
There’s reason to be nervous
I would have to agree with Wilson that the market may be getting ahead of itself here, although I’m not as pessimistic as Wilson with his price target for the S&P 500.
My concern is that the market is currently in a little bit of a no-win situation in the near term. If the labor market stays hot, there will be no recession, which also likely means there will be no interest rate cut, either. Many believe a rate cut is needed to drive stock prices higher. But if the situation rapidly changes, which could happen given the level of rate hikes the Fed just did, then there might be a recession. If it’s more severe than a mild recession then the market could also struggle.
Most analysts coming into the year expected the market to have a tough first half of the year followed by a rebound in the second half. So far the first half has been pretty good, and it’s by no means a given that the Fed is ready to stop raising rates — let alone cutting rates. That’s why I’m staying cautious right now.
Bram Berkowitz has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.