Morgan Stanley
  • Wealth Management
  • Jan 10, 2023

The History Lesson Smart Investors Need to Learn

Bullish investors may be ignoring the historical context for today’s strong corporate performance. That could be dangerous for their portfolios.

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It’s important for investors to stay focused on both the short and long term, but it is easy to get myopic in a world of constant news flow and daily market action. Investors could end up paying too much attention to the recent past when making assumptions and estimates, while losing sight of historical context.

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Many investors seem to be displaying this sort of short-sightedness now. In particular, they seem to be overlooking how the largest stimulus program in U.S. history, precipitated by the pandemic, has kept current profit margins and demand levels running above long-term trends. 

For example:

  • The operating margin of the S&P 500 Index, at 11.6%, is still near the all-time high of 13.1% reached in late 2021—notably above pre-pandemic levels of 10.2% and the rolling 10-year average of 9.4%.
  • 2022 nominal revenues for S&P 500 companies were 8% above the 10-year trend.
  • Last year’s real, or inflation-adjusted, consumption was about 7% above its long-run trend.

These above-trend numbers underpin today’s consensus forecasts for 2023 S&P 500 earnings growth of nearly 4% to $228 per share. However, Morgan Stanley’s Global Investment Committee thinks such projections are overly optimistic and put too much faith in corporate resilience while lacking historical perspective.

Importantly, considering that margins and demand levels remain so far above historical trends, we are likely to see performance revert to long-run average levels. This alone—to say nothing of a potential economic recession this year—could bring a meaningful correction in corporate results and asset prices.

Investors may be overlooking two risks in particular:

  • The U.S. labor market remains tight. Recent jobs data showed a greater-than-expected number of jobs created in December and a drop in the unemployment rate back to the 50-year low of 3.5%. While wage growth appeared to slow, structural changes in the labor market could continue to sustain wage gains, especially in still-understaffed service industries. These dynamics could weigh on company margins, while potentially providing cause for continued Federal Reserve tightening.
  • Inventories have swelled. While there has been some clearing of inventory from last year’s highs, overall inventories for general merchandise retailers are still 28% above the 10-year trend. This suggests new orders are likely to weaken and consumer demand will soften. 

These dynamics should give investors pause, as they point to the potential dangers of anchoring forecasts to recent results without incorporating historical context. Again, today’s corporate earnings estimates reflect neither a reversion to pre-pandemic trends nor an actual economic slowdown, and as a result are likely to disappoint.

We advise investors to watch for excesses to be fully wrung out of estimates, which would help recalibrate 2023 and 2024 expectations more in line with historical averages. Investors should consider rotating portfolios toward fixed income, value-style stocks, global dividend payers, early cyclicals, enterprise tech and emerging market stocks.

This article is based on Lisa Shalett’s Global Investment Committee Weekly report from January 9, 2023, “The Dangers of Myopia.” Ask your Morgan Stanley Financial Advisor for a copy. Listen to the audiocast based on this report.

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