Some deteriorating market indicators and the end of major pandemic relief programs suggest a coming plunge of more than 20 percent in U.S. stocks as the economy returns to a more normalized pace. The transition could be rougher than many expect, according to Morgan Stanley, which is considered more bearish than most Wall Street strategists.
In a note to clients, chief US. Morgan Stanley Equity Strategist Mike Wilson said that the market is at a fork in the road with one road leading to “fire” and the other to “ice,” . The market appears to be heading down the ice path.
“The ‘ice’ scenario is starting to look more likely, and could result in a more destructive outcome – i.e. a 20%+ correction,” the note said.
The “fire and ice” debate, inspired by the Robert Frost poem — “Some say the world will end in fire;
Some say in ice” — originated in the late 1990s between two Morgan Stanley researchers. On one side of the debate, Barton Biggs took the position that the world would freeze over as a glut of cheap Asian labor hit the world market. On the other, Steve Roach, then the firm’s chief economist, now a senior fellow at Yale, predicted an inflationary bonfire, according to the U.K.-based Oxford-Man Institute of Quantitative Finance.
“The typical ‘fire’ outcome would lead to a modest and healthy 10% correction in the S&P 500,” Morgan Stanley strategists said in the note. But it’s the more bearish “ice” scenario that’s gaining traction, they said, which could mean the economy sharply decelerates and earnings get squeezed.
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Wall Street has had an abnormally long gap without at least a 5-percent pullback, CNBC reported. Stock futures slid on Monday morning as the Dow Jones Industrial Average came off three-straight losing weeks.
Morgan Stanley identified several factors that could extend the market’s decline:
“Given the extraordinary fiscal stimulus during this recession, we are concerned that the inevitable deceleration in growth will be much worse than what is currently expected. This is the ‘ice’ scenario and would likely lead to a larger than normal mid-cycle transition correction in the S&P 500—i.e. 20%,” the note said.
Wilson predicts a “rolling correction” as the market transitions out of the spring and summer economic rebound. His year-end target of 4,000 for the S&P 500 is almost 10 percent less than where the stock closed on Friday.
The “ice” scenario will happen if earnings revisions and higher-frequency macro datapoints slow down, Wilson noted.
The more optimistic near-term risk path for the stock market, “Fire,” would occur if the Federal Reserve begins to remove monetary accommodation as the U.S. economy overheats.
“Ice, the more likely of the two outcomes, they said, would be ‘destructive’,” Business Insider reported.
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