- Next year will see extreme volatility as the economy grapples with the boom-bust inflation cycle, Morgan Stanley's Mike Wilson said.
- He said economic dynamics are more akin to the 1940s versus the 1970s.
- The boom-bust cycle could mean weak earnings ahead for companies.
Investors should be prepared for "extreme volatility" in 2023, as the US economy steers through 1940s-style boom-bust inflation, according to Morgan Stanley chief investment officer Mike Wilson.
"We don't think it's the 70s, we think it's more of the 40s, where it's a boom-bust," the top stock strategist said in an interview with CNBC on Tuesday. He compared the current inflation cycle to the demand-driven inflation that took root in the economy after World War II.
In the 40s, supply and demand eventually balanced out – but inflation remained sticky, which could be a clue to what lies ahead for the economy next year, Wilson said. Already, that trend is starting to show, and despite softening demand and improving supply issues, inflation is still well above the Fed's 2% target, with prices barely cooling to 7.7% in October.
"Inflation can't ebb as quickly as it flows when demand falls by the wayside and supply picks up. And that's exactly what we see in 2023," Wilson said.
Sticky inflation spells trouble for the Federal Reserve, which has been scrambling to hike rates and rein in high prices. Already, the central bank has raised its benchmark rate by nearly 400-basis-points this year, raising alarm on Wall Street that the Fed could tip the economy into a recession -- spurring even greater volatility in the stock market.
In particular, Wilson pointed to one indicator of future volatility: the drop in the M2 money supply, which includes cash, checking deposits, and highly liquid deposits. M2 growth has plunged from 27% at the start of 2021 to just 2.5% today – a contrast from the previous decade, when stocks were buoyant, rates were low, and the economy was highly liquid.
"We're going into an environment where an economic variable, volatility, is going to be extreme. And that's a difficult operating environment, and some companies will do a good job of that and some won't. But it creates probably a lot more dispersion, quite frankly, across the stock market," Wilson said, warning investors of mixed corporate earnings results next year.
Wilson has previously warned of earnings weakness to come. He noted that while earnings results were largely positive in the past quarter, that's masking more pain ahead, since recession risks haven't been fully priced into the market. The release of fourth quarter earnings in February is likely to end the current bear market rally, he said, predicting the S&P 500 to bottom out early next year.