US stocks set for a significant pullback? Wall Street: This year's gains will be preserved!

Top Wall Street strategists have differing views on the outlook for US stocks, largely depending on the future direction of the economy and the Federal Reserve.

What determines the future direction of US stocks?

For optimists, a recession this year is no longer possible.

If inflation continues to slow down, as it did last year, it means that the Fed's job is almost done. Rising interest rates could be good news for the stock market.

Pessimists argue that if the economy is too strong, the Fed may need to further tighten monetary policy to restore price stability, rather than easing it next year.

Most market strategists and chief investment officers expect the Fed not to raise rates again in the current cycle, with a few expecting only a 25 basis point increase by the end of the year.

And how long the benchmark interest rate will remain at today's level is still an undecided question.

"Wall Street's most famous bear": bearish on US stock profits

Mike Wilson, Chief Strategist at Morgan Stanley, believes that declining inflation could benefit bond prices and price-to-earnings ratios, but it could be a potential obstacle to profit growth for US stocks.

For more companies, this would mean a decrease in pricing power and narrowing profit margins. This is exactly what Wilson predicts; he expects S&P 500 companies to earn $185 per share this year, well below the industry analysts' consensus estimate of $220.

Wilson recommends overweighting healthcare and utility stocks (Health Care Select Sector SPDR Fund (XLV) and Utilities Select Sector SPDR Fund (XLU)). He states that healthcare stocks are "high-quality defensive stocks" with relatively low valuations and minimal cyclical risks. Utilities also have defensive characteristics and tend to be the last industry to struggle during market downturns.

Wilson is bearish on expensive tech stocks and non-essential consumer stocks, and he expects the S&P 500 to decline in the fall of this year due to the significant weight of these stocks in the index. His year-end target is 3,900 points, which implies a decline of over 10% from recent levels.

Short-term difficulties for US stocks?

The head of stock strategy at a major bank believes that US stocks may face short-term difficulties.

He states that as expectations for the Fed continue to change, US bond yields may rise further in the coming weeks. Additionally, historically, September has been a period of seasonal weakness in the stock market.

However, later this year, he expects US bond yields to decline again, and US stocks will rebound driven by the largest companies in the market. It is projected that for the remainder of this year, the S&P 500 will fluctuate between 4,200 and 4,600 points, reaching 4,420 points by the end of 2023.It is expected that with the arrival of autumn, concerns about the economic outlook for 2024 will intensify. This is unfavorable for cyclical stocks but may lead to the market digesting the Fed's interest rate cuts next year, thereby reducing US bond yields and benefiting growth stocks. The result may be that people flock to the largest, most successful, and theoretically most stable companies in the market.

US stocks are more expensive than US bonds

Currently, the valuation of the S&P 500 index is not severely overvalued, at 19 times the expected earnings for the coming year, but it also does not reflect unfavorable economic outcomes.

Compared to bonds, it is expensive: US bond yields are higher than the peak in October 2022, when the S&P 500 index was around 3600 points.

"Typically, this situation occurs when we are in the late stage of the cycle," Wilson said. "In the absence of conclusive evidence, people's views are determined by price behavior. The fact that US stocks have risen significantly enhances the view that a soft landing is more likely."

Recent price trends indicate that although US stocks may not experience significant gains, they will retain most of this year's increase. Next year will bring new challenges - after all, it is an election year.