US stocks risk sharp decline

Amid recent turmoil in the banking sector, the prominent bearish voice on US stocks, Morgan Stanley’s Michael Wilson, has warned that earnings guidance may be too high, putting sanguine stock markets at risk of sharp declines.

In a note released on Monday, Wilson explained, “given the past few weeks, we think guidance is looking more and more unrealistic, and equity markets are at greater risk of pricing in much lower estimates ahead of any hard data changes.” 

That, in part, is due to the divergence in stock and bond market action this month. While bond volatility has spiked, as investors priced in a potential recession following the collapse of a slate of regional US lenders, equities have recovered losses on bets of intervention from policymakers.

The first quarter earnings season, which starts in mid-April, will be in focus in the coming weeks. Wilson pointed out that the drop in profit estimates so far this year has matched the declines seen in the previous two quarters. That indicates that earnings may not have bottomed out yet. 

He added that given expectations of a sharp profit recovery in the second half, the threat to margins from elevated inflation is still “underappreciated.”

JPMorgan Chase & Co. strategists echoed Wilson’s sentiment, stating that the first quarter likely marked “the high point” for stocks this year. However, they don’t expect a “fundamental improvement in equities risk-reward” until the Federal Reserve signals rate cuts. 

Additionally, the team led by Mislav Matejka anticipates that rising recession odds this year will likely invert the relationship between bonds and stocks, which moved in the same direction last year, making it unusual.

As uncertainty continues to loom over the stock market, investors will likely keep a close eye on upcoming earnings reports and policy announcements from the Federal Reserve.

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