Stock markets are turbulent and Morgan Stanley is warning clients the ride is about to get even bumpier.
Investors have "very few places to hide" in markets right now, with even defensive stocks succumbing to the pressure in recent days, Morgan Stanley equity strategists led by Mike Wilson wrote on Monday.
"The market has been so picked over at this point, it's not clear where the next rotation lies," Wilson wrote. "In our experience, when that happens, it usually means the overall index is about to fall sharply with almost all stocks falling in unison."
Morgan Stanley says the backdrop "suggests" the S&P 500 will enter a bear market, signaling a 20% decline from previous highs. Recent selling may support the view that markets are moving into a "much broader sell-off phase," the bank said.
US stocks fell sharply last week -- including a drop of nearly 1,000 points on the Dow on Friday alone -- on worries about the aggressive steps the Federal Reserve will take to tame very high inflation. Including Monday's modest losses, the S&P 500 is down about 12% from record highs set in early January.
The S&P 500, the broadest gauge of US stocks, has been in a bull market since late March 2020 when the Federal Reserve came to the rescue with unprecedented support amid the deep recession caused by Covid-19.
However, the Nasdaq tumbled into a bear market in early March as oil prices skyrocketed and inflation fears mounted.
Morgan Stanley said investors are buying into the bank's fire-and-ice narrative of an overheating market and economy that get dramatically cooled off. The closing chapter, Morgan Stanley said, is a "fast tightening Fed right into the teeth of a slowdown."
Others are more optimistic about the risks that inflation poses to the stock market and economy.
"Inflation should ease from current levels, and we do not expect a recession from rising interest rates," Mark Haefele, chief investment officer at UBS Global Wealth Management, wrote in a note to clients on Monday.
Indeed, some economists are hopeful that inflation may finally be at or near a peak.
Morgan Stanley shares that view, although the bank doesn't see that as a positive. Instead, Morgan Stanley says easing inflation will be accompanied by slower GDP, sales and earnings growth -- all negatives for stocks.
"While others have been using this as a bullish argument," Morgan Stanley wrote, "we would like to send a clear warning -- be careful what you wish for."
