‘Deteriorating quickly’: U.S. earnings revisions could knock stocks down another 5% to 10%, warns Morgan Stanley

The U.S. stock market has tumbled this year amid high inflation that the Federal Reserve is trying to tame by raising interest rates. The S&P 500 index SPX, +1.86%, which narrowly averted a bear market last week, is down 16.6% in 2022 through Monday.

Against the backdrop of rising rates and the jump in inflation, “positive earnings momentum has been critical in moderating stock market losses,” said Shalett. “But as inventory rebuilding matures and consumers shift their purchases toward services and away from goods, earnings expectations are having their day of reckoning.”

Read: Buy the dip? Sell the ‘rip’? What’s ahead for stock investors as ‘sticky’ inflation fears heighten consumer concern.

In Shalett’s view, “2022 was apt to be a year of paybacks,” after “extraordinary” results in 2020 and 2021 benefited from record government stimulus during the COVID-19 pandemic. The Fed is now tightening monetary policy to cool the economy as it aims to rein in the surge in cost of living.

The stock market’s “repricing has been driven by the reset in inflation expectations and the Fed’s plan for interest rates and balance sheet reduction,” she wrote. “The next phase is a recalibration of profit and economic forecasts from the unsustainable levels of the V-shaped 2020-21 recovery.”

That “rerating” has started, said Shalett. She pointed to earnings misses last week in the retail and technology sectors “due to excess inventories, high costs and price-related demand destruction.”  

Major U.S. stock benchmarks ended sharply higher Monday, with shares in the financials sector SP500.40, +3.23% driving gains for the S&P 500 index. The S&P 500 closed up 1.9% Monday, the Dow Jones Industrial Average DJIA, +1.98% climbed 2% and the Nasdaq Composite COMP, +1.59% gained 1.6%, according to FactSet data.