(Bloomberg) -- This week’s US inflation print and Federal Reserve decision might be at the forefront of most investors’ minds, but for some of Wall Street’s most prominent strategists it’s the prospect of future profit downgrades that’s the biggest worry for stocks.
According to notes from Morgan Stanley’s Michael Wilson and Goldman Sachs Group Inc.’s David Kostin, earnings could contract more than expected in 2023 as margins come under pressure, providing a difficult backdrop for equities.
“The final chapter to this bear market is all about the path of earnings estimates, which are far too high,” Wilson wrote in a note on Monday. The consumer price index reading and Fed meeting are “yesterday’s news,” said the strategist, who ranked No. 1 in the latest Institutional Investor survey.
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Both Wilson and Kostin see a tough start to 2023 for equities, following a year in which many major indexes fell into bear markets before a fourth-quarter rally. Soaring inflation and rising interest rates have until now been central to investor concerns, and that’s likely to remain the case — for the short-term, at least.
The Fed on Wednesday is set to raise its key rate by 50 basis points to a range of 4% to 4.5%, the highest since 2007, and to signal more increases in early 2023. The day before that, November’s consumer price index is expected to show that while inflation is decelerating, it remains too high for comfort. The S&P 500 slid 3.4% last week on concerns that a strong US economy will keep the Fed on its aggressive policy tightening path, putting the benchmark on track for its worst year since 2008.
Looking further ahead, Wilson expects a very challenging environment for earnings in 2023 as “costs will remain elevated and prices received by companies will fall.” His Goldman Sachs (NYSE:GS) counterpart is of a similar view, saying margins could weigh on estimates more than forecast. Kostin’s team expects no appreciation in either profit or the S&P 500 next year.
Goldman sees the benchmark ending the year at 4,000, while Wilson expects it to close at 3,900 points, roughly in line with current levels.
And while an informal survey of 134 fund managers conducted by Bloomberg showed some of the world’s biggest investors predict that stocks will see low double-digit gains next year, not everyone is convinced by this scenario.
“Many investors have a more bearish equity market outlook than we do,” Kostin wrote. While he assumes a soft landing in 2023, equity returns would be worse than expected if the US economy enters a recession, he said.