- Morgan Stanley suggested that the next equity bear market may already be underway, and it says it sees a deterioration in earnings growth coming in the second half of the year.
- The firm shared ideas about how an imminent downturn will vary from other recent bear periods.
As the equity bull market forges ahead into its ninth year, all types of investors have been busy trying to figure out when it'll all come crashing down.
But if Morgan Stanley is to be believed, the demise of the second-longest bull run in history may be underway. After all, the firm argues, a bear market in stock valuations has already begun.
If that's the case, why aren't people more alarmed? Morgan Stanley says it's because the deterioration of market conditions has been overshadowed by a new tax law that has given corporations a temporary and unsustainable earnings boost.
So the firm expects earnings-per-share growth to slow in the second half of the year as the positive effect wears off.
The chart below shows Morgan Stanley's one-year leading earnings indicator forecasting the downturn. Such a slowdown would mark the end of a good run for companies in the S&P 500 that have enjoyed seven straight quarters of profit expansion.
"We expect both a deterioration in earnings quality and a peak in organic growth in 2018," Mike Wilson, Morgan Stanley's chief US equity strategist, wrote in a client note. "The bear market in valuations has already begun and supports our overall view that the next cyclical bear market in US equities may have already begun, but is being masked by an index price level that has fallen only 12% thanks to the adrenaline shot to EPS from tax."
That's all well and good then, right? Stock bears will get what they've wanted for so long, and the overall market will get the sharp and unforgiving drop it's been bracing for.
Not quite, says Morgan Stanley, which is predicting a bear market that would ultimately be "unsatisfying" for equity naysayers.
The firm argues that the drop will lack the 20-40% pullbacks that have characterized the past three bear periods dating back to 1987.
For context, consider those past three bear markets. The most recent one, which lasted for 517 days from October 2007 to March 2009, saw a whopping 57% plunge in the S&P 500. During the 929-day bear market from March 2000 to October 2002, the benchmark lost 49%. And in a 101-day period from August to December 1987, the index tumbled 34%.
With that in mind, how does Morgan Stanley think this go-around will differ?
"Instead, we are likely to see a rolling bear market across individual stocks and sectors that results in a choppy, range-trading index for years," Wilson said.
You know, like the market we've seen so far in 2018.
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