Prepare for Downtrend and Volatility Next 3 Months as S&P 500 'Remains Overvalued' - MS

Morgan Stanley top equity strategist Michael Wilson has once again issued a warning to investors that “there is still a long way to go before reality is fairly priced.”

The road towards likely new lows in the U.S. stock market will be volatile as Wilson fails to identify an "event" to clear the decks. While the risks from high earnings estimates and growth are elevated, the strategist doesn’t see them necessarily priced in.

“The current S&P 500 equity risk premium remains ~120 bps too low. The fair value multiple, incorporating a 10-year yield that is testing 3.50%, is now down just below 14X—a reflection of the Fire and Ice dynamic still present in this market,” Wilson said in a note.

Although valuations have compressed this year in response to the tighter financial conditions, Wilson reiterates that the “S&P 500 remains overvalued” based on Morgan Stanley’s framework that suggests the Equity Risk Premium (ERP) is “significantly underpriced.”

Wilson again reiterated the bank’s view that the S&P 500 will bottom near 3400, or around 3000 in case the bear-case scenario plays out (recession).

“We expect a downward and volatile primary price trend over the coming 3 months.”

While Wilson remains bearish both fundamentally and technically on a 3-month basis, he is more neutral-biased for the next 9-12 months.

“With that backdrop, we continue to recommend owning more defensively oriented companies with earnings stability and high operational efficiency,” Wilson concluded.

By Senad Karaahmetovic

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