Why Morgan Stanley Says Get Out Of Stocks Now

Given that big Wall Street firms are almost perpetually bullish about stocks, Morgan Stanley is raising eyebrows these days by advising investors to head for the exits -- and do it now. "We struggle to see the upside in hanging on just to see how long we can. We think it is better to hop off now and rest up for the next rodeo,” says Michael Wilson, the chief equity strategist at Morgan Stanley. “Maybe the bull ride since Dec. 24 has not gone a full ‘8 seconds’ but we’d look to dismount anyway--we’re close enough and bulls can be dangerous animals.” Regarding this rodeo reference, a completed bull ride lasts for 8 seconds.

Wilson, who made his comments in a note to clients quoted by MarketWatch, cited two main reasons for his pessimism, as outlined in the table below.

2 Reasons To Get Out of Stocks

• EPS growth only 1.3% to 3.5% in first three quarters of 2019
• GDP hit of $11 billion from partial government shutdown

Source: Morgan Stanley; MarketWatch

Wilson notes that the double-digit year-over-year (YOY) profit increases posted by many U.S. corporations in 2018 were the result of lower tax rates in 2018 versus 2017. This scenario will not be replicated when 2019 earnings are compared to 2018.

However, Wilson is among the most bearish observers. The consensus view among analysts is calling for 6.4% earnings growth in full year 2019 for the S&P 500 Index (SPX), per Zacks Investment Research. The figure is 5.8%, based on I/B/E/S data cited by Yardeni Research. By contrast, Wilson sees EPS growth as low as 1.3% for the first three quarters of the year.

Wilson is also concerned about the five-week partial shutdown of the U.S. federal government. The Congressional Budget Office (CBO) estimates that it has cost the U.S. economy $11 billion, but that $8 billion eventually will be recovered once federal employees receive back pay, Reuters reports. The government reopened this week pursuant to a stopgap spending bill that funds it for three weeks.

"We doubt a three week reopening of the government is going to lead to a full rebound of economic activity that was lost or suppressed. Some things likely can't be 'made up' even if the temporary reopening becomes permanent," Wilson says. The CBO estimates that the shutdown reduced the economy's growth rate in the fourth quarter of 2018 by 0.1 of a percentage point, and that the negative impact on full year 2019 growth will be only 0.02 of a percentage point. However, significant effects will continue to be felt by individuals and businesses that were not paid during the shutdown, Reuters notes.

Stocks historically have posted strong gains in the 12 months after a shutdown ends, per research by LPL Financial. But, in this case, history may not be a guide since the recent 35-day shutdown was by far the longest ever, eclipsing the previous record, a 21-day closure that ended in Jan. 1996. The S&P 500 advanced by 21.3% in the 12 months after that shutdown.

In fact, Daniel Pinto, co-president of JPMorgan Chase, is one strategist who says stocks could plunge instead of rise. He expects more market meltdowns in the range of 10% to 20%, per reports by CNBC. A prime reason cited by these market watchers is slowing economic growth in the U.S., Asia, and globally, exacerbated by the unresolved trade tensions between the U.S. and China.

Economists at Bank of America Merrill Lynch recently cut their 2019 GDP growth projection for the U.S. from 2.7% to 2.5% based on the trade situation, MarketWatch notes, adding that inventories rose during the shutdown. Inventory buildups, in turn, often signal falling demand and spending. Morgan Stanley earlier this year warned that the risk of a recession is the highest since the 2008 financial crisis, leading them to project a stock market decline in 2019, per a previous report.

Only a few months ago, a major Wall Street firm's recommendation that investors abandon the stock market entirely would have seemed outlandish. So Wilson's draconian EPS estimates are indicative of how pessimism is spreading among leading players in the market. Since stock prices are driven by expectations, Wilson's outlook may be another indicator that investors should proceed with additional caution.