Morgan Stanley’s Chief Equity Strategist, Mike Wilson, has doubled down on his call for stocks to continue falling through the end of 2022 in part due to reduced dollar supply in some of the world’s largest economies.
Even with Monday’s rally, U.S. stocks are likely to remain lower for the foreseeable future, as volatility across equities, bonds, commodities and currencies could remain elevated, Wilson said, in a client note Monday.
The S&P 500 SPX,
has fallen more than 6.5% since Monday September 6, a day after Wilson published an earlier note calling for another leg lower in stocks. Among Wall Street’s top analysts, Wilson is widely credited with correctly predicting the latest bear market in stocks this year.
Look: Here’s what Morgan Stanley says will trigger another decline in stocks
The problem, according to Wilson, is that as interest rates continue to rise and the Fed shrinks its balance sheet, it could risk triggering a crisis somewhere in the world, or even in the United States.
This is because higher interest rates put pressure on the US economy by making it more expensive for corporations and households to borrow money, and a stronger dollar makes it harder for emerging economies to borrow which is denominated in dollars to pay back.
If this happens, the Fed will likely be asked to reverse course on the aggressive monetary tightening it has promised to help fight inflation.
Problems have already begun to emerge, Wilson said, referring to “M2” data, the main measure of dollars in circulation. this shows that the money supply has been decreasing over the past 12 months.
“The US dollar is very important to the direction of risk markets and that is why we track M2 growth so closely,” Wilson said.
M2 for the “big four” economies: the US, China, the euro area and Japan, reached a peak in March 2021, after which there was a decline of $4 trillion, according to Wilson data.
Tracking the rate of change in the money supply for these economies is important, Wilson said, since it tends to correlate with lower equity prices, as the chart below shows.
This contraction in the money supply is occurring at a time when the dollar is DXY,
trading near its strongest level in 20 years.
Look: The US dollar posted its strongest quarter in at least 7 years as investors sought safety
When could the Fed finally reverse course? Wilson said investors should watch for signs that the stronger US dollar is becoming a problem at home.
As MarketWatch reported, the strong US dollar has become a “wrecking ball” for global financial markets, and is also adding to fiscal pressures in many emerging economies whose dollar-denominated debt has become a greater burden still on them.
Look: Why the US dollar’s epic rally could be a ‘wrecking ball’ for financial markets
It remains to be seen whether the Fed will be enough to stop its campaign of interest rate hikes and balance sheet reduction to stop a crisis. The Fed may have to reverse course and cut rates.
FED Chairman Jerome Powell argued that the Fed could not risk cutting interest rates prematurely in case inflation could be even closer.
Regardless, stocks are likely headed lower until the Fed’s pivot finally arrives, Wilson said. adding that prospects for that policy change may be enough to trigger a sharp, but short-lived, rally in stocks.
However, Wilson said it would likely already be too late to avoid an earnings recession, which is typically defined as two quarters of negative earnings growth for the S&P 500.
Wilson’s argument for pivoting the Fed comes under pressure as more individuals and organizations complain about the blowout from the central bank’s rate hikes.
On Monday, the United Nations Conference on Trade and Development said in a report that the Fed could seriously damage the economies of developing nations if it continues to raise borrowing costs.
Look: The UN calls on the Fed, other central banks to stop interest rate hikes
After securing their worst monthly performance since March 2020 on Friday, US stocks have started October and the fourth quarter in the green, with the S&P 500 rising 2.7%, the Dow Jones DJIA industrial average,
up 2.8% and the Nasdaq Composite COMP,
an increase of 2.4%.
Look: It was the worst September for stocks since 2002. What does that mean for October.