Is the worst over for stocks or not? Morgan Stanley and JPMorgan disagree

The deep uncertainty of the investment environment was underscored by reports from top Wall Street strategists, who were divided on their estimates of the path the stock market will take in the second half of the year, amid uncertainty over the Fed’s stance in the shadow of deterioration of economic data.

In particular, while analysts at Morgan Stanley say it’s too early to expect the Fed to stop its policy tightening, even as fears of a recession grow – suggesting stocks have more room to fall – those of JPMorgan Chase argues that bets that inflation has peaked will lead to a change in stance by the Fed, improving the market picture in the second half.

Persistent inflation will keep the Fed hawkish for longer this time, according to Michael J. Wilson of Morgan Stanley, Bloomberg reports.

While during its last four cycles the US central bank had stopped its policy tightening before the start of an economic contraction and signaled a rise in stocks, today’s record highs in inflation mean that the Fed will likely continue even when it has come recession, he said in a note.

Stocks “might try to get ahead of a possible pause in Fed tightening that always gives a bullish signal,” he noted, but added that “the problem this time is that the pause is likely to be too late.”

In contrast, JPMorgan’s Mislav Matejka said in a note today that anemic economic momentum and a slack labor market could open the door to a more balanced policy from the Fed, leading to a further rise in the dollar and a peak in inflation. .

The S&P 500 tried to recover this month and is on track for its biggest monthly gain since October after plunging in the first half of the year as corporate earnings came in better than the market had feared, while much negative news were already billed.

Investors have now turned their attention to the Fed’s meeting on Wednesday, when the central bank is expected to raise interest rates by another 75 basis points, as it did last month, in its biggest rate hike since 1994. .

For his part, Paolo Zanghieri, senior economist at Generali Investments, said he expects the pace of rate hikes to slow after this week’s meeting.

But concerns are mounting that the Fed may be too late in its bid to tame inflation while averting a US recession. More than 60% of the 1,343 respondents to the latest MLIV Pulse survey said there was little or no chance the central bank would limit price pressures without triggering an economic contraction.

At Jefferies, strategist Sean Darby expects that although the economic slowdown is growing, the pressure on stocks from monetary policy tightening will ease in the second half.

“Unlike the words ‘recession’ and ‘hyperinflation’ that have fueled many headlines, the ‘shift’ (ie the Fed’s policy) has yet to draw the same attention,” he wrote in a note.

“In any case, if the shapes in the US Treasury yield curve and Fed rate futures are correct, then the headwind from hikes will be limited somewhat as tightening enters the latter part of the year.”

Notably, Morgan Stanley’s Wilson, who was among the most pessimistic on US stocks and correctly predicted the general sell off, said that while inflation may indeed have peaked “in terms of the rate of change”, the impact in consumer demand “will not go away easily even if inflation falls sharply, because prices are already out of reach in sectors of the economy that are critical to the expansion of the cycle.”

A growing number of analysts also estimate that with inflation stubbornly at a four-decade high, it will take a recession – and significantly higher unemployment – to significantly reduce price pressures.

For JPMorgan’s Matejka, another factor improving the outlook for stocks in the second half is a shift in the reaction to corporate earnings, where weaker results can start to be seen as good news.

Wilson disagrees, however, saying that earnings estimates for S&P 500 companies are still too high and that the second quarter could be the first of “many disappointing quarters before estimates finally come down.” As such, stocks may have more room to fall before bottoming out, he adds.

For his part, Goldman Sachs Group strategist David J. Kostin also sees pressure from the stronger dollar on S&P 500 earnings. The bank’s model shows that a 10% appreciation of the dollar would lead to a decline in earnings per share by 2% to 3%, he wrote in a July 22 note.