Morgan Stanley
Wealth Management

3 Risks That Could Derail U.S. Stocks

Apr 18, 2023

Cracks in the labor market, worsening business conditions and weak corporate earnings bode ill for equities.

Author
Lisa Shalett
Lisa Shalett

Key Takeaways

  • U.S. stock investors appear overly optimistic about the health of the economy and corporate earnings.
  • Signs of weakness in the labor market, deteriorating business conditions and lower earnings estimates are causes for concern.
  • Investors should focus on income and yield opportunities.

With stocks continuing to post gains into the second quarter—marked by an 8% rise in the S&P 500 Index this year—bullish equity investors appear full of optimism. They seem to believe that inflation has been tamed, the Federal Reserve is nearly done raising interest rates and will soon begin to cut, and that corporate earnings will be resilient.

 

This rosy outlook underpins today’s very rich equity valuations but likely leaves little room for any “upside,” or the potential for further gains, and more important, may set up equity investors for disappointment.

 

We believe the market’s resilience overlooks the growing risk of an economic recession as the Fed comes to the final stages of its rate-hiking cycle. Here are three risks investors should watch:

  1. 1
    The labor market is starting to show cracks.

    March’s nonfarm payroll employment data highlighted a better-than-expected gain of 236,000 jobs, labor-force participation on the rise and an unemployment rate near a record low. However, the Job Openings and Labor Turnover Survey (JOLTS) showed the biggest drop in job openings over three years, with postings falling below 10 million in February. Initial unemployment claims are also edging higher as small businesses slow their hiring, job-cut announcements rise and consumer sentiment falls. 

  2. 2
    Bank lending is slowing, and business conditions may be worsening.

    The two weeks ending March 29 saw the largest decline in loans and leases at commercial banks in nearly 50 years. In a recent National Federation of Independent Business (NFIB) survey, 9% of small businesses reported that financing was harder to get than three months ago, the highest rate since December 2012. Also consider corporate bankruptcy data: Following multi-decade lows in 2022, bankruptcy filings in the first three months of 2023 were the most in any first quarter since 2010.

  3. 3
    Companies are lowering their first-quarter performance forecasts.

    According to FactSet, 78 companies have cut first-quarter estimates already, the most since the third quarter of 2019. Many of these trimmed outlooks are coming from the tech and industrials sectors. Investors’ expectation that first-quarter results will mark the worst of this economic cycle—even before we’ve seen a true slowdown in the economy or an uptick in unemployment—seems naïve.

It should be no surprise to investors that one of the most severe monetary policy tightening campaigns in 40 years is now beginning to weigh on the economy. Investors should pay attention to first-quarter corporate earnings results and performance forecasts from company management, which may point to a slowdown ahead.

 

Investors deploying new cash should focus on income and yield opportunities in both stocks and bonds. Many equity bulls point to “cash on the sidelines” as a reason that stock prices may yet edge higher. But with valuations rich and cash-like instruments offering yields of 4­–6%, stocks—especially market-cap-weighted index funds—look less compelling.

 

This article is based on Lisa Shalett’s Global Investment Committee Weekly report from April 17, 2023, “Bad Is Now Bad.” Ask your Morgan Stanley Financial Advisor for a copy. Listen to the audiocast based on this report.

Find a Financial Advisor, Branch and Private Wealth Advisor near you. 

Check the background of Our Firm and Investment Professionals on FINRA's Broker/Check.

Wealth Management Why U.S. Stocks Remain Vulnerable Strains in commercial real estate and other assets may be raising the risk for equities.
Wealth Management Why Investors Should Brace for ‘Stagflation’ Turmoil in the banking system increases the odds of recession, higher unemployment and untamed inflation. Here’s how to prepare.
Wealth Management How Investors Should Play the 'Hot' Economy With economic data coming in stronger than expected, and inflation persisting despite Fed action, what should investors do now?
Why U.S. Stocks Remain Vulnerable
Wealth Management Why U.S. Stocks Remain Vulnerable
Why Investors Should Brace for ‘Stagflation’
Wealth Management Why Investors Should Brace for ‘Stagflation’
How Investors Should Play the 'Hot' Economy
Wealth Management How Investors Should Play the 'Hot' Economy

More Insights

Discover more insights for your portfolio. 

Wealth Management Portfolio Insights Thoughts on the Market

Index Definitions

S&P 500 Index: The Standard & Poor's (S&P) 500 Index tracks the performance of 500 widely held, large-capitalization US stocks.

Risk Considerations

Equity securities may fluctuate in response to news on companies, industries, market conditions and general economic environment.

The value of fixed income securities will fluctuate and, upon a sale, may be worth more or less than their original cost or maturity value. Bonds are subject to interest rate risk, call risk, reinvestment risk, liquidity risk, and credit risk of the issuer.

High yield bonds (bonds rated below investment grade) may have speculative characteristics and present significant risks beyond those of other securities, including greater credit risk, price volatility, and limited liquidity in the secondary market. High yield bonds should comprise only a limited portion of a balanced portfolio.

Companies paying dividends can reduce or cut payouts at any time.

Asset allocation and diversification do not assure a profit or protect against loss in declining financial markets.

Investing in small- to medium-sized companies entails special risks, such as limited product lines, markets and financial resources, and greater volatility than securities of larger, more established companies.

Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies. Technology stocks may be especially volatile. Risks applicable to companies in the energy and natural resources sectors include commodity pricing risk, supply and demand risk, depletion risk and exploration risk. Health care sector stocks are subject to government regulation, as well as government approval of products and services, which can significantly impact price and availability, and which can also be significantly affected by rapid obsolescence and patent expirations.

The indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment.

The indices selected by Morgan Stanley Wealth Management to measure performance are representative of broad asset classes.  Morgan Stanley Wealth Management retains the right to change representative indices at any time.

Disclosures

Morgan Stanley Wealth Management is the trade name of Morgan Stanley Smith Barney LLC, a registered broker-dealer in the United States. This material has been prepared for informational purposes only and is not an offer to buy or sell or a solicitation of any offer to buy or sell any security or other financial instrument or to participate in any trading strategy.  Past performance is not necessarily a guide to future performance.

Morgan Stanley Smith Barney LLC, its affiliates and Morgan Stanley Financial Advisors do not provide legal or tax advice.  Each client should always consult his/her personal tax and/or legal advisor for information concerning his/her individual situation and to learn about any potential tax or other implications that may result from acting on a particular recommendation.

This material, or any portion thereof, may not be reprinted, sold or redistributed without the written consent of Morgan Stanley Smith Barney LLC.

© 2023 Morgan Stanley Smith Barney LLC, Member SIPC.

CRC# 5630024    (04/2023)

View Disclosures Close Disclosures