In a note on Monday, Morgan Stanley strategists made the case that the first-quarter earnings season, which just recently began, won’t be as strong as initially expected due to rising supply costs for businesses.

“Signs are emerging that 1Q earnings season may be more disappointing than [we] thought, particularly from a guidance/forward estimate standpoint,” the Morgan Stanley team wrote. 

The strategists, led by Michael J. Wilson, said they expect that first-quarter earnings reports could reveal a widespread drop in the earnings per share that companies report, and warned that businesses will cut their upcoming earnings forecasts. That’s bad news because stock prices typically fall after companies reduce their expectations for future earnings growth, the bank said. 

U.S. businesses posted record profits in 2021 by passing rising costs on to consumers, but with annual inflation jumping to a four-decade high of 8.5% in March, Morgan Stanley says that tactic is unlikely to be sustainable. 

The investment bank’s strategists argued consumers are now less receptive to price increases than they have been over the past year, citing evidence from the University of Michigan’s consumer sentiment survey. That means companies will be forced to bear the brunt of inflationary pressures, which will hurt profit margins moving forward.

“Margin expectations look overly optimistic…given the myriad of cost pressures companies face,” the strategists wrote.

The Morgan Stanley Business Conditions Index—a survey of dozens of the investment bank’s analysts—also fell to its lowest level since April 2020 on Friday, indicating businesses are struggling to find their footing amid rising prices. 

While inflation at the consumer level has been making headlines for months, the producers’ price index (PPI), which measures the average change in the price of goods and services received by domestic producers, continues to show even more dramatic increases. In March, the PPI jumped a record 11.2% year over year.

While Morgan Stanley still isn’t forecasting a recession, at least over the next six to 12 months, it does see the potential for the S&P 500 to fall roughly 8% to 4,000 over the next two months.

Morgan Stanley’s pessimistic forecast follows other top investment banks’ predictions of an impending recession. Deutsche Bank said earlier this month that rising inflation coupled with the war in Ukraine will push the U.S. and Europe into a recession in 2023.