Wall Street’s leading bear is doubting himself, a little. Here’s what is worrying Morgan Stanley’s Mike Wilson now

Arguably Wall Street’s most pessimistic voice has been so surprised by the market rally that he is questioning the firm’s own corporate earnings model.

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“Given we have been so wrong about the S&P 500 this year, we have been trying to decide if our earnings model may be misleading us,” says Mike Wilson, Morgan Stanley’s chief U.S. equity strategist.

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The short answer, he concludes, is no. “Actual earnings have been tracking our earnings model perfectly for the past year, which means the model appears to be performing well even in this higher inflationary regime – something we were concerned about a year ago,” said Wilson.

Last week’s data showing weaker-than-expected producer prices — cheered by the market — portends a sharp drop in revenue over the next four months, he says. “Such a decline in revenue growth would imply that our well below earnings forecast is correct as the negative operating leverage does the heavy lifting,” he says.

While the firm backs the potential for artificial intelligence, it won’t be enough to prevent the deceleration already in motion for this year, and in fact for 2023 will for most companies be a cost that will pressure margins further.

Wilson pours cold water on the recent broadening of the market rally from megacap tech stocks to regional banks and small caps.

“We have been watching these areas too and while there may be some stabilization in these areas, it’s hardly impressive,” said Wilson.

One mistake he will concede was on the impact of the bailout of depositors, and whether it was a form of a monetary stimulus. “At the time, we said it was Not QE,” says Wilson.

“While that is true from a technical aspect – i.e. the Fed/FDIC are not buying bonds, but rather lending money to banks temporarily – it did add liquidity to the system and allowed banks to continue operating and extending credit.”

Also see: This incredible chart shows the close relationship between the S&P 500 and Fed liquidity

That liquidity is set to evaporate, he says, with the issuance of Treasury bills after the debt-ceiling impasse was resolved. Wilson says up to $500 billion will be funded from bank reserves.

“Historically speaking, the equity market does not trade well when we see such a drawdown in bank reserves. Combined with the fiscal drag, this should be a challenging cocktail for equity investors,” he says.

U.S. stock futures were weaker on Tuesday after a three-day break. But the S&P 500 has gained for five straight weeks and has climbed 15% this year.

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