Top Wall Street strategist warns that excessive government spending may be causing a boom-bust scenario in the stock market.

Top Wall Street strategist warns that excessive government spending may be causing a boom-bust scenario in the stock market.

The Prospects of U.S. Equities: A Look at Fiscal Policy and Stock Valuations

Stock Market

In the world of finance, opinions on the state of the stock market can vary widely. Some investors remain bullish, riding the wave of a booming economy and ever-increasing stock valuations. Others, like Morgan Stanley’s chief U.S. equity strategist, Michael Wilson, take a more cautious stance. Wilson believes that the U.S. government’s fiscal policies may be setting equities up for problems further down the line.

Despite the turbo-charged U.S. economy and rapid monetary tightening by the Federal Reserve, Wilson argues that prolonged fiscal stimulus could widen the government deficit. This concern is shared by credit rating agency Fitch, which recently downgraded America’s credit rating. While the government highlights the positive impact of its spending on GDP growth and cooling inflation, Wilson questions the excessiveness of fiscal spending when considering the low U.S. unemployment rate of just 3.5%.

Moreover, the recent selloff of government bonds, which fund fiscal expenditure, can have consequences for the stock market. Wilson predicts that investors will start questioning equity valuations and that an earnings decline, which began last year, might resume if fiscal spending is curtailed due to higher political or funding costs.

In an interview with Bloomberg, Wilson reiterates his concerns about the U.S. government’s use of fiscal ammunition. He points out that an 8% budget deficit spending paired with a 3.5% unemployment rate is unprecedented. If a slowdown occurs next year, it could potentially dampen stock valuations, supporting his “boom-bust” thesis.

While the S&P 500 has experienced a strong rally this year, with almost a 20% increase, Wilson remains skeptical. He refuses to raise his price targets for the index, believing that the bear market is still alive. He warns of the risk in overlooking current valuations and suggests a possible retracement back to the 200-day moving average of around 4,100 points.

Wilson is not alone in his cautionary predictions. JPMorgan CEO Jamie Dimon also expresses concerns about increased government interventions and their potential ineffectiveness. Dimon emphasizes the importance of carefully implementing fiscal policies to avoid past failures.

Wilson himself has a history of making bearish predictions about U.S. stocks. In May, he warned investors not to be fooled by the S&P 500 rally, predicting an imminent 20% downturn. However, he admits that 2023 has been a story of higher valuations amid falling inflation and cost-cutting, which did not align with his projections. Reflecting on his earlier instincts, Wilson acknowledges that he should have adjusted his market calls in January to account for the unexpected fiscal impulse.

Looking ahead to June 2024, Wilson’s base case scenario sees the S&P 500 dropping to around 4,200 points, a decline of just 7% from current levels. However, in a bear case scenario, he anticipates a more severe drop to around 3,700 points, equivalent to a nearly 20% decrease from current levels.

In conclusion, the debate surrounding the prospects of U.S. equities remains fierce. While some remain optimistic about the continued growth of the stock market, strategists like Michael Wilson urge caution, highlighting the potential risks posed by excessive fiscal spending and inflated equity valuations. As investors navigate these differing viewpoints, it will be crucial to stay informed and make carefully calculated decisions amidst the changing market landscape.