Mike Wilson, chief investment officer for Morgan Stanley, has warned for months that the rally in U.S. equities was a mirage, even as stocks kept rising. 

Just over a month ago, Wilson was forecasting that the S&P 500, in his worst-case scenario, could fall by 14% by June 2024. Then, in mid-July, the analyst warned that companies were still overvalued, with higher interest rates and falling liquidity putting pressure on stock prices, even if second-quarter earnings came in “better than feared.”

Yet the current rally, close to erasing all of last year’s decline, has proved too durable for Wilson to stick to his forecast. “We were wrong,” Wilson admitted in a note to clients on Monday, according to Bloomberg. “2023 has been a story of higher valuations amid falling inflation and cost cutting,” he continued. 

Morgan Stanley is now looking to June 2024, predicting that the S&P 500 will settle at 4,200, just 8% below where it is today.

Still, Wilson sees some warning signs ahead. “We remain pessimistic on 2023 earnings,” he wrote, as inflation falls “even faster than the consensus expects.” Up until now, companies have been able to increase prices—thanks to high inflation—and keep sales growth above zero, he notes. (For example, PepsiCo reported growing revenue and profits last quarter thanks to price increases, despite falling sales volume in some categories.)

But companies will have less ability to keep prices high as inflation recedes, Wilson warns. More firms are downgrading their profit forecasts than those upgrading them, Morgan Stanley notes.

Top strategist in 2022

Wilson was ranked the top stock strategist in a survey last October from Institutional Investor, owing to his prediction that U.S. equities would fall in 2022, even as consensus predicted a slight rise of 1%. 

The analyst’s worst-case scenario was that the S&P 500 would hit 4,000 by the end of the year, owing to interest rate hikes and slower economic growth. The S&P 500 did worse than that, ending the year at 3,839, a 20% drop. 

That plunge has since reversed. The index is up just over 19% in 2023 thus far, and it’s only around 5% below the record value recorded on Jan. 3, 2022. 

Around 170 companies on the S&P 500, including heavyweights like Microsoft, Meta, and Alphabet, will report quarterly earnings this week, notes Bloomberg.

Investors may be jumpy in the event of a weak forecast. Shares in S&P 500 constituent Netflix are down by over 10% since last Wednesday, after the company gave a below-expectations forecast for revenue for the coming quarter.

And there’s one more event to watch out for. The Federal Reserve will announce its latest decision on interest rates on Wednesday. While most analysts predict the central bank will raise rates this month, observers will be looking for signals as to whether July’s expected hike will be the central bank’s last, or whether the Fed thinks the fight against inflation isn’t quite over.