- Recent revenue misses from techs and retailers are worrying investors, Morgan Stanley's Lisa Shalett said.
- Snap's profit warning this week rattled stock markets, as its CEO spelled out the headwinds for companies.
- More earnings cuts are likely and could push already struggling markets a further 5-10% lower, the investment chief said.
A string of eye-catching earnings misses by tech and retail leaders signals it's payback time for stocks boosted by pandemic-era stimulus — and that could pull markets lower, according to Morgan Stanley's Lisa Shalett.
As companies face new headwinds, investors can expect to see a shock from earnings revisions, which are deteriorating quickly, Shalett said in a note this week.
"The market narrative has turned from concerns about the Federal Reserve's ability to execute a soft landing for the economy and tame inflation, to concerns about corporate earnings and the risk of recession," she said.
"Indeed, certain misses in corporate earnings last week shone a light on rising costs denting company profits and dampening consumer demand," she wrote.
The wealth management CIO's comments come in a week when a cut in earnings outlook from Snap hit the stock market, helping drive losses not just in techs, but across the board.
Shares in the Snapchat parent plummeted as much as 38% Tuesday, while Facebook parent Meta slid 9% and Twitter dropped 2%.
Snap's CEO warned that "the macroeconomic environment has deteriorated further and faster than anticipated" in 2022, which would hit hiring and revenue growth for the social-media platform for the rest of the year.
The likes of Walmart, Target, Amazon and Google parent Alphabet pointed to similar pressures in recent updates, as they warned on profit and missed earnings targets.
Corporate earnings surged in 2020 and 2021, fueled by record government stimulus that skewed demand among consumers towards goods and to "stay at home winners" in the early days of the pandemic, Shalett noted.
The Fed's monetary policy tightening and slower economic growth have dented these trends, as the central bank aggressively hikes interest rates to tame red-hot inflation.
"It seems inevitable that there was going to be some payback in corporate earnings this year," Shalett said.
"With fiscal stimulus ending, consumers spending more on services at the expense of goods, and inflation hitting corporate expenses, earnings would take a hit."
Morgan Stanley has warned that even the biggest megacap tech companies are unlikely to be immune from the triple threats of tighter policy, higher inflation and a stronger dollar.
"With last week's notable earnings misses in the retail and tech sectors due to excess inventories, high costs and price-related demand destruction, the next phase of stock rerating has begun," Shalett said.
US 75-day earnings revisions were the worst among all markets, including European, Asia-Pacific, and emerging markets, according to Morgan Stanley.
Stocks have slid in 2022 as investors worried about the Federal Reserve's monetary tightening, the risk of an economic slowdown, soaring inflation and the impact of the Ukraine war.
The tech-heavy Nasdaq has fallen the most, down almost 25%, while the S&P 500 is off nearly 15% and flirted with bear territory, and the Dow Jones has dropped over 10% in the year so far.
With a potential recession looming in the background, an earnings revision shock could drag down US stock markets further, according to Shalett.
"Ultimately, we estimate that stock market indexes could suffer another 5% to 10% downside from this resetting of earnings expectations," she said.
The Morgan Stanley investment chief recommended using market volatility to move portfolios toward maximum diversification, quality factors and active management. She recommended deploying cash in investment grade bonds, non-US stock funds, and cyclicals like financials, energy, and industrials.
