As the Q2 earnings season started to wrap up, things were looking good for the stock market. Not only had investors seen one of the best earnings quarters in recent history, but news of Pfizer’s (NYSE: PFE) vaccine approval had helped assuage fears concerning new coronavirus cases. However, that optimism wasn’t to last. Now that we’re almost one-third through September, investors are starting to get concerned, whether about rising delta cases or the possibility that stocks have become overvalued. One of Wall Street’s top has just warned that stocks could make a major nosedive sometime this year.
Morgan Stanley analysts said that U.S. stocks are precariously priced right now. Despite being largely optimistic about the state of the markets in the long term, the investment bank now thinks that valuations have become too high for most companies. Major indexes have been trading at record highs throughout most of 2021, an extent to which otherwise has rarely been seen before in recent history.
The main risk factor, according to Morgan Stanley, is that investors are now expecting another fantastic quarter of results. Sooner or later, things are going to slow down, as these current expectations are far from realistic, nor are they sustainable. When that starts to happen, stocks are expected to see a pretty big dip.
“The issue is that the markets are priced for perfection and vulnerable, especially since there hasn’t been a correction greater than 10% since the March 2020 low. The strength of major U.S. equity indexes during August and the first few days of September, pushing to yet more daily and consecutive new highs in the face of concerning developments, is no longer constructive in the spirit of ‘climbing a wall of worry,'” said Morgan Stanley’s chief investment officer Lisa Shallet.
In particular, growth stocks have been skyrocketing in value, as they tend to do during booming markets. The opposite is true when the markets switch to a low-growth environment, where dividend-yielding companies fare significantly better.
This isn’t the only potential warning sign that the investment bank has given. Earlier this month, Morgan Stanley said that it expected Q3 annualized economic growth to fall significantly from 6.5% to just 2.9%. Other banks, like Goldman Sachs, had predicted Q3 economic growth to hit 8.5%. Now the bank cut its forecast to just 5.7%, still significantly higher than Morgan Stanley.
Whether stocks will really decline this year or not is yet to be seen. However, what is undebatable is that the American economy is showing some startling signs that it’s slowing down. According to the Bureau of Labor, total job openings in the U.S. hit over ten million, while monthly hires (for the month of July) were just over six million. That means businesses are struggling to hire employees right now, despite unemployment remaining quite high at around 6.0%.
With all this in mind, traders will be paying close attention to this month’s Federal Reserve meeting. Among other things, they’ll be watching closely whether Jerome Powell will pull back on asset purchases earlier than anticipated. There’s certainly potential for September to become a very choppy month.
