Stocks will drop as the economy is either about to enter a recession or the Fed is poised to keep rates higher for longer, Morgan Stanley CIO says

• Stocks are set to fall further, Morgan Stanley’s top stock strategist Mike Wilson predicted.

• That’s because the economy is either headed for a recession or the Fed will keep interest rates high.

• Both factors will weigh on corporate earnings, which are likely to fall below estimates, Wilson said.

Stocks are set to fall further, as investors realize the economy is either headed for a recession or the Federal Reserve is poised to keep interest rates higher for longer, according to Morgan Stanley’s top stock strategist Mike Wilson.

In a podcast on Monday, Wilson pointed to recent upbeat sentiment in the stock market, likely because investors are expecting the Fed to cut interest rates later this year, all while maintaining expectations for further economic growth. But the probability of both of those happening are low, he said, and that spells trouble for corporate earnings, and in turn, the stock market.

“We believe the equity market continues to expect the best of both worlds: interest rate cuts and durable growth,” Wilson said. “Instead, we believe another chapter of our fire-and-ice narrative is possible: in other words, a tighter Fed even as growth slows towards recession. This will be a difficult environment for stocks,” he later warned.

Wilson has warned before that stocks are facing a “fire-and-ice” scenario, in which high inflation and the possibility of a recession will weigh on corporate earnings. Though investors have been encouraged by surprisingly strong earnings over the past quarter, a continuation of the trend isn’t supported by the economic data, Wilson said.

“If one is to believe our leading indicators that point to downward trends in earnings-per-share surprising margins in the coming months, stocks will likely follow that negative path lower,” he added.

Wilson has predicted that the worst earnings recession since 2008 could hit the market this year, which could take stocks down 26%.

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That comes after an already difficult year for equities, with the S&P 500 losing 20% in 2022 as the Fed aggressively hiked interest rates to tame inflation. Higher rates have significantly raised the odds of recession, experts say, and they’ve also weighed heavily on corporate profits by raising the cost of borrowing.

The Fed hiked interest rates another 25 basis-points last week, lifting the Fed funds rate target to 5-5.25%. Investors are pricing in a 33% chance the Fed could cut rates as soon as July, per the CME FedWatch tool, though that possibility has been dismissed by other Wall Street strategists, who say the Fed will pause and then keep rates elevated.

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