The S&P 500 may fall 6% next year and investors will find better returns in European and Japanese equities, says Morgan Stanley

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  • The S&P 500 has risen 25% in 2021, but it is likely to fall from record highs to 4,400 in 2022, Morgan Stanley said on Monday.
  • Earnings growth of 45% has helped pull the benchmark above 4,700, but the expansion is set to slow down next year and in 2023.
  • Morgan Stanley’s stock market outlook is instead more positive on European and Japanese stocks.

The S&P 500 is set to deliver double-digit returns in 2021, but the benchmark is likely to retreat next year as earnings growth slows, said Morgan Stanley analysts, who advised investors to turn to European and Japanese equities.

The S&P 500 has risen 25% during 2021, rising to record highs of over 4,700 by building on its 2020 increase of 16% as it recovered from a pandemic-driven bear market. Before the corona crisis hit, the index rose by about 29% in 2019.

However, it looks set to lose steam next year, with Morgan Stanley expecting it to fall back to 4,400. That level represents a 6% drop from where the S&P 500 was on Monday.

“With financial conditions tightening and earnings growth slowing, the 12-month risk / reward for the broad indices looks unattractive at current prices,” equities analysts led by Mike Wilson said in a note released Monday.

The key to the S&P 500’s jump this year has been Corporate America’s earnings, which have been “the most bullish by 2021” by growing by about 45% or 7% above Morgan Stanley’s initial estimate.

But the red-hot pace is likely to calm in 2022, with a 10% increase in S&P 500 earnings to $ 227 per share, followed by an 8% increase in earnings in 2023 to $ 245 per share.

“While our economists remain optimistic about GDP growth for next year, we are cutting earnings growth for higher costs and taxes (in 2023), as our political team still expects the bill on Build Back Better spending to be passed before the end of the year. These adjustments shave about 4% off [per-share earnings] in 2023, everything else being equal. ”

Morgan Stanley said 2022 marks a stock-picking year, urging investors to focus less on sectors and styles. “We are entering the end of the year and favoring earnings stability and demanding valuation given our views on a tougher operating environment and higher long-term interest rates,” it said.

That view puts the bank’s preponderance on health, real estate and financial stocks and is more constructive in the consumer / business services sectors and “reasonably priced” software, “Wilson said.

Meanwhile, Morgan Stanley’s strategists in Europe said they were overweight in European and Japanese equities, noting a potential downside for the S&P 500.

“[We] “believes that 2022 is, in fact, about ‘mid-to-late-cycle’ challenges: better growth in the face of high valuations, austerity policies, rampant investor activity and higher-than-expected inflation,” he wrote. European analysts led by Andrew Sheets “Navigating these will be about finding an adjustment in risk premiums and fundamentals,” as they see exist in, among others, Europe and Japanese equities.

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