Morgan Stanley sees corporate earnings falling in 2023, but a sharp rebound in 2024

Morgan Stanley strategists led by Michael Wilson expects U.S. corporate earnings to decline, and along with them, equities averages, on the premise that the Federal Reserve won't loosen policy this year, liquidity will suffer as the Treasury sells bonds to replenish its coffers, and growth isn't as durable as markets are pricing in.

They expect S&P 500 EPS to drop 16% Y/Y in 2023 followed by a "sharp rebound" in 2024. "This out-of consensus earnings path is supported by our models and our view that policy will become more accommodative in 2024, not in 2023," Wilson and colleagues wrote. Their thesis also contends that "we are in the midst of several 'hotter but shorter' earnings cycles in the context of a broader secular bull market (a 'boom/bust/boom' regime)."

Their S&P 500 target for next 12 months equates to 4,200. Meanwhile, their base case S&P 500 target for end-2023 remains at 3,900. S&P 500 (SPX) at Monday, 11:31 AM ET, was 4,292.

Drivers for a 2024 recovery include more accommodative monetary policy as the pace of inflation slows; a more stable starting point for consumer balance sheets overall; AI and its spread across sectors; improvement in productivity, industrial automation and the capital spending cycle; a shift to positive operating leverage and margin expansion; cleantech and reshoring of cleantech critical infrastructure; and the shortage of U.S. housing supply.

Morgan Stanley makes several trade recommendations — consumer staples over consumer discretionary; high over low return on invested capital; defensives over cyclicals; high operational efficiency + Morgan Stanley Overweight ratings; long health care; and strong pricing power.

From a sector standpoint, the strategists remain Overweight on health care, consumer staples and utilities.

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