MORGAN STANLEY: This earnings season is the ‘moment of truth’ for stocks. Here’s why the signs are pointing to a major disappointment for investors.

  • First-quarter earnings are about to gear up, and Morgan Stanley’s chief US equity strategist is warning that the market is set for a “gut check.”
  • Michael Wilson says investors will be disappointed and stocks gains will be limited unless those earnings reports include real signs that growth is picking up.
  • He doesn’t think that’s going to happen: He’s forecasting an “earnings recession” and modest losses for stocks through the end of 2019.
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Corporateearningsare starting to roll in, andMorgan Stanley‘s chief US equity strategist is warning that it’s a do-or-die moment for the stock market.

Considering theS&P 500has already soared 15% this year, Mike Wilson says Wall Street will want to see clear signs that growth will pick up in the months to come. And if that evidence doesn’t materialize, he thinks stocks are going to struggle.

“Earnings season offers a gut check for a market looking for some evidence that the worst is truly behind us,” he wrote in a note to clients. “The moment of truth is here.”

Experts are predicting a small dip in earnings in the first quarter, much of which they’re pinning on temporary obstacles likethe partial government shutdown. There’s also the matter of the abnormally large profit growth companies enjoyed in the first quarter of 2018, when the GOP tax plan was still generating gobs of fresh capital. That makes any year-over-year comparison a difficult one.

But it’s what happens next that has Wilson thinking differently than most other experts. And his argument is built around company forecasts, which he says will be critical.

Wilson says he won’t be surprised if CEOs and other executives maintain their guidance for the rest of the year, feeling that the worst is behind them — even though it’s not clear that it actually is. That could set the stage for disappointment later on.

“If we don’t get the reacceleration now baked into the consensus expectations, it will be treated as a disappointment by investors,” he wrote.

That’s one reason he expectsthe S&P 500to finish the year at 2,750, about 5% lower than it is right now.

Wilson has consistently been more pessimistic than most people on Wall Street. While analysts think profits will start growing again in the second quarter and wind up with growth of about 5% this year, Wilson expects an “earnings recession,” meaning at least two quarters of flat or negative earnings growth.

That’s illustrated by this chart. Wilson says analysts are expecting earnings growth to quickly recover to its 2017 pace, but he doesn’t see much evidence that that’s going to happen.

Analysts expect company earnings to improve later this year, but Mike Wilson of Morgan Stanley has doubts about that pickup.
Morgan Stanley Equity Research and Refinitiv

Earnings consistently come in better than analysts expect, which might create some hope that profits will end up a bit better than the first quarter of last year. Wilson warns investors not to expect that because estimates have fallen so sharply. When that happens, he said, companies typically don’t beat expectations by very much.

“A lowered bar into the quarter does note mean the likelihood of a beat is greater,” he wrote. “The forecasts for (first quarter 2019) have been lowered substantially and we do not think we are going to see a beat big enough to lift index growth into positive territory.”

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