S&P 500 set to drop another 15% to 20% in price in recession, says Mike Wilson at Morgan Stanley

The price is not right.

That’s the verdict of strategists at Morgan Stanley and Goldman Sachs, who warned as a new week began that the stock market was not fully pricing in a recession. And that’s like US SPX stocks,
got off to a solid start with trading resuming after Monday’s June 1 holiday.

“With our view of lower multiples and gains now more consensual, markets are priced more fairly. However, it does not price the risk of a recession, in our opinion, which is 15-20% lower, or around 3,000,” said Mike Wilson, Morgan Stanley’s chief U.S. equity strategist and one of the most bearish voices on Wall Street this year. , in a note on Tuesday. “The bear market will not end until the recession hits or the risk of one is extinguished.”

To read: Elon Musk joins a chorus of Wall Street analysts in predicting a US recession

Wilson sees much of Wall Street still assuming much higher price-earnings ratios for year-end S&P 500 price targets. His bank was “far out of consensus” in 2022, with a forecast of a more than 20% drop in valuations – now they are down 28% year-to-date. But Morgan Stanley MS,
analysts have continued to downgrade their assessment as bond yields rise, with the current P/E ratio of 15.3 incorporating an equity risk premium (ERP) of 330 basis points, too low in their view.

Wilson would like to see the ERP at 370 basis points, which would leave the S&P 500 P/E ratio falling to 14x, as long as TMUBMUSD10Y,
and earnings estimates are stable. ERP represents the extra return investors expect on riskier stocks over risk-free bonds.


Echoing some of Wilson’s thoughts was Goldman Sachs’ chief global equity strategist Peter Oppenheimer, who sees market prices at risk of only a mild recession, rather than a medium or deep contraction. He sees the current bear market as cyclical and a function of the economic cycle, according to Goldman Sachs GS,
research note Tuesday.

“Most bear markets end when economic conditions are still bad, but there is a sense that they are no longer deteriorating at the same rate,” Oppenheimer told clients in the note. “Even if eventually yields don’t rise much further, it seems likely that markets will at least price in risk before we can see a genuine recovery.”

U.S. financial conditions are not that tight by historical standards, so either rates need to rise further or markets need to reassess risk, which would serve as tightening either way, he said.


The S&P 500 tends to lose a third of its value, on average, around a recession, according to RBC Capital Markets.

“The average drop was 32%,” analysts at RBC, led by head of US equity strategy, Lori Calvasina, said in a note on Tuesday. “That kind of decline would take the S&P 500 to 3,262 this time around.”

The average decline from peak to bottom of the S&P 500 around a recession is 27%, which would drag the S&P 500 to 3,501, the note shows.

“The 3500 area is a major support and stress test for a secular bull market defined by the 200-week rising moving average” and the 50% retracement of the rally seen from March 2020 to January 2022, according to a BofA Global Research market analysis note dated June 20th.

The US stock market was trading higher on Tuesday afternoon, with the S&P 500 up 2.8% to around 3,777, according to FactSet data, at the latest check. The index is down about 21% this year based on Tuesday afternoon trading.

“Last week, we were on the road talking to investors in two different regions of the US,” RBC analysts said. “Most moved away from debating whether a recession is coming and were thinking about when it would start, how long it would last, how deep it would be and conditions on the other side.”

The meetings were primarily with “long-only institutional investors that we consider to be of longer duration and focused on fundamental equity pricing,” according to the note.

Several of the investors told RBC they had already “cut the edges and were sticking to high-quality names that they like for the long term,” the analysts said. “Several also told us that they already had much higher cash balances than usual.”

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