Morgan Stanley says the stock market is headed for a downturn and will bottom by spring

“While the recent rise in front-end interest rates supports the notion that the Fed may remain hawkish longer than anticipated, the stock market refuses to accept this reality,” a team led by Michael Wilson wrote in a note.

Wilson — a staunch Wall Street bear who correctly predicted last year’s sell-off when U.S. stocks posted their worst performance since 2008 — expects deteriorating fundamentals, along with Fed hikes that come at the same time as an earnings recession, to weigh on stocks going to an ultimate low this spring. “Price is about as disconnected from reality as it has been during this bear market,” the strategists said.

Last week, US 2-year bond yields topped 10-year yields by the highest since the early 1980s, a sign of flagging confidence in the economy’s ability to withstand additional rate hikes. Meanwhile, US stocks had one of the strongest starts to the year on record, although the rally gradually cooled as Fed Chair Jerome Powell’s outlook for further rate hikes weighed on sentiment.

US inflation data could be a catalyst to bring investors back to reality and bring stocks back in line with bonds if prices rise more than expected, Wilson said while noting that expectations for such an outcome have risen. Tuesday’s data is expected to show that consumer prices rose 0.5% mom in January, boosted by higher fuel costs. That would be the biggest gain in three months.

Wilson expects the S&P 500 to end the year at 3,900 index points, about 4.7% below where it closed Friday, with a bumpy ride to get there. He expects stocks to fall as earnings estimates fall before recovering in the second half of the year.

“The risk/reward ratio is at its worst during this bear market,” Wilson wrote. “The reality for equities is that monetary policy remains on restrictive territory in the context of an earnings recession that has now started in earnest.”

Other strategists are less pessimistic. Goldman Sachs Group Inc.’s Christian Mueller-Glissmann upgraded global equities from underweight to neutral over the next three months, citing reduced upside risk for bond yields and more confidence in a soft landing in the US.

However, he remains selective as “higher valuations and more upbeat growth sentiment increase the risk of stocks falling.” While there is limited room for further recovery for Wall Street stocks, “we still see attractive upside potential for non-US stocks,” Mueller-Glissmann wrote in a note.