- The odds of a 20% correction in the S&P 500 depend on how much earnings growth in the third quarter will slow, Morgan Stanley said.
- “We are confident of a stronger slowdown, but the timing is more uncertain,” strategists said.
- The benchmark index has so far been corrected by 6% before suffering a recent rebound.
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The odds of a correction of up to 20% in the S&P 500 depend on how much earnings growth in the third quarter slows or falls, Morgan Stanley said in a note this week.
“We are confident of a stronger downturn, but the timing is more uncertain,” strategists led by Michael Wilson wrote in a note to clients.
A downward scenario is a path that strategists in September called “Ice,” which would emerge if upward earnings revisions slowed and higher-frequency macro data points deteriorated. The upward scenario, they called “Fire,” is a more optimistic perspective that would emerge if the Federal Reserve begins to retreat to accommodative policies as the U.S. economy warms.
The market hit fire after the Fed announced that it would finally tighten monetary policy. Now they are waiting for the timing and size of the ice, which will determine when the mid-cycle transition will be over, they said.
“Our fire and The ice thesis is taking place, “they said. Declining growth is normal during the mid-cycle transition for both finance and earnings. This time, however, the deceleration in growth may be greater than normal. “
The S&P 500 has been volatile and choppy in recent weeks as it catches up with rotations and rolling corrections, strategists said, adding that this was expected.
“The S&P 500’s more erratic behavior since early September has coincided with the Fed’s more aggressive focus on downsizing asset purchases,” they said. “Although the average stock has already experienced a 10-20% correction this year, the S&P 500 has avoided it, at least so far.”
S&P has seen a correction of about 6% from recent highs, analysts noted.
“As of today, this de-rating is roughly halfway based on past mid-cycle transitions,” the strategists said. “Whether this correction is 10%, 20% or is already over will be determined by what happens to earnings revisions over the next few months.”