Brace for US stocks to crash again – their extreme valuations echo the 2022 bear market, Morgan Stanley strategists warn

• US stocks look as overvalued as when the 2022 bear market kicked off, Morgan Stanley warned.
• Investors should brace for another crash, the bank's wealth management strategists said.

Get ready for US stocks to crash again, because they're looking overvalued — just like they did at the start of the bear market last year, Morgan Stanley strategists have warned.

"The stock market and the credit market are fighting the Federal Reserve's likely path of rising interest rates. US stock valuation is at an extreme," the team in the bank's wealth management division said Monday.

In their note to clients, the strategists said their analysis showed US stock prices at levels similar to those reached just before 2022's brutal slump kicked off, pulling the S&P 500 down 19.4% for the year.

At the start of 2023, US share prices rose to regain some ground, as investors grew hopeful the Fed would hold off from more interest-rate hikes. The central bank raised rates from near zero to around 4.5% in the past year as it tried to cool high rates of inflation.

But the Morgan Stanley Wealth Management team said that rally has dragged valuations — an assessment of a stock's fundamental worth — to extreme levels.

They warned those levels show a disregard for the potential threats of rising interest rates or an economic downturn. Investors are concerned the Fed's determination to bring down inflation could end up harming the US economy.

"The real damage for the cycle, such as an economic soft landing or a recession, may still be ahead," the team, led by CIO Lisa Shallett, said. "Caution is warranted."

The strategists pointed to the S&P 500's 12-month price-to-earnings ratio as evidence that stocks are just as overvalued as they were before last year's crash.

The key P/E metric allows investors to analyze the trading price of a stock and compare it with others, to help decide how much it reflects the stock's true value. It's a measure of the price in relation to its earnings per share.

The S&P 500 index had a P/E ratio of 21.64 as of Monday's closing bell – just below the 22.40 level it reached in April 2022. The US benchmark plummeted 20% between April and October last year, while the tech-heavy Nasdaq Composite crashed 27%.

Morgan Stanley Wealth Management's gloomy outlook echoes the bearish view held by the bank's top strategist.

CIO Mike Wilson said Monday that he was expecting a short-term rally – but warned that markets are still running on "borrowed time" before a US recession drags down earnings and stock prices.

Read more: The bear market rally isn't over yet as stocks just survived a crucial test, Morgan Stanley CIO says