Wall Street strategists are getting nervous about stock rally

A rally that’s pushed US stocks to a new record this year will stall if company earnings disappoint, according to two of Wall Street’s most bearish strategists.

Morgan Stanley and JPMorgan Chase & Co. are growing concerned as the outlook for profits has been weakening even as the S&P 500 reaches fresh highs. Equity gains over the past five months have been driven by easier financial conditions and higher valuations rather than improving fundamentals, according to Morgan Stanley’s Michael Wilson. 

“Further multiple expansion in the US is likely dependent on an upward inflection in earnings expectations,” a team led by Wilson wrote in a note. “It’s hard to justify the higher index-level valuations based on fundamentals alone, given that 2024 and 2025 earnings forecasts have barely budged over this time period.”

According to data compiled by Bloomberg Intelligence, consensus earnings estimates have been revised lower over the past five months, with analysts currently expecting earnings-per-share to grow about 9% this year versus 11% at the start of November. But while profit estimates have been falling, US stocks have continued to rally amid optimism about potential rate cuts and developments in artificial intelligence, with a stronger-than-expected fourth-quarter results season also helping.

JPMorgan’s Mislav Matejka is also worried about the disconnect between earnings expectations and share prices.

“Our concern is that profit growth could underwhelm, for a number of reasons,” a team led by Matejka wrote in a note. “If the earnings acceleration fails to materialize, this could act as a constraint.”

Morgan Stanley and JPMorgan are some of the most pessimistic strategists at major Wall Street banks. JPMorgan sees the S&P 500 ending the year at 4,200 index points — a 20% drop from the most recent close — while Wilson expects the benchmark to drop to 4,500 points.

One point of concern for bearish strategists is the narrowness of recent equity-market gains, which have been driven by the Magnificent Seven. The market will need to broaden out for the rally to continue from here, Wilson wrote.

Separately, RBC Capital Markets strategist Lori Calvasina noted the outperformance of the top stocks on the S&P 500 is stalling after hitting new highs. “We continue to see sentiment as stretched and think a US equity market pullback is overdue,” she wrote.