Morgan Stanley Wealth Management’s investment chief said in a note to clients this week that the US economy is increasingly likely to be hit by a recession — and stocks are still pretty much down.
Morgan Stanley’s Lisa Shellett estimated the likelihood of an economic downturn has doubled to more than 50% as the Federal Reserve aggressively raised interest rates to combat inflation.
While the stock market has already plunged into a bear market, many companies have yet to fully attribute the Fed’s sharply tightening of its earnings forecasts. Chalet reasoned that the stock could drop 5% to 10% before turning down.
“We do not think the cyclical bear market can end until earnings are marked down, which makes profit reports for the second and third quarters important,” Chalet wrote in Tuesday’s research note.
The Fed raised interest rates by three-quarters of a percentage point earlier this month, the first time since 1994 that level has been raised. Fed Chair Jerome Powell has indicated that a half percentage point or three-quarter increase is likely at the central bank’s next meeting in July.
The broad-based S&P 500 fell into a bear market earlier this month and is down nearly 21% so far this year. A bear market is defined as a drop of 20% from recent highs.
While the prospects of a recession are rising, the Morgan Stanley analyst said it is likely to be “shallow” in nature as elements of the economy remain strong. He pointed to strong fundamentals such as “flexible” housing prices, a tight labor market and solid household balance sheets.
“Historically, the damage to corporate earnings has been more modest during inflation-induced recessions,” Chalet said in an accompanying blog post.
Fortune and Business Insider reported on Shellett’s note. Morgan Stanley did not immediately return a request for comment.
Morgan Stanley is one of several firms that have warned that a recession could be imminent as the Fed moves forward with its plan. Citigroup recently pegged the probability of a recession at 50%, while Goldman Sachs has pegged the probability at 30%.
Meanwhile, Powell and Treasury Secretary Janet Yellen are among those who have insisted that an economic slowdown is not inevitable.
During a panel discussion on Wednesday, Powell said the Fed must risk a recession to effectively address inflation that stood at 8.6% in May.
“Is there a risk that we will go too far? There is certainly a risk,” Powell said. “To make a big mistake – let’s put it this way – would be to fail to restore price stability.”