By Senad Karaahmetovic
Don’t be confused by an ongoing rally in U.S. equities as bear markets are “designed to confuse investors and take their money,” Morgan Stanley equity strategists wrote in their weekly note.
Don’t pay too much attention to the noise and “trust your fundamental process” as the strategists continue to see much lower levels from here in the coming months.
“We advise staying focused on the fundamentals and ignoring the false reflections,” they wrote.
The analysts have the “highest conviction” that the Q4 earnings season will be weak, mostly due to softening margins. Given valuations, they believe the market is not prepared for the upcoming disappointment.
“The spread between our earnings model and consensus forecasts is nearly as wide as it's ever been and suggests a drawdown in stocks for which most are not prepared. The main culprit is the elevated and volatile inflationary environment which is likely to play havoc with profitability. Our negative operating leverage thesis remains underappreciated and will likely catch many off guard starting with this earnings season,” the strategists added.
Morgan Stanley continues to see new lows in the S&P 500, the thesis boosted by “the shift in investor tone.”
“Our call has a better chance of playing out if we're right on the magnitude and timing of our earnings forecast. We double down on our well below consensus earnings forecast; we think the timing for meaningful downward revisions is likely to be during the first quarter,” they concluded.