Morgan Stanley says it was wrong to write off stocks – but warns cooling inflation could still kill the rally

• Morgan Stanley's top strategist has been one of Wall Street's most bearish voices this year.
• Mike Wilson said Monday he'd been "wrong" to write off stocks, with the benchmark S&P 500 up 19% year-to-date.

One of Wall Street's most pessimistic strategists said Monday that he'd stayed bearish on stocks for too long this year, missing out on the massive AI-fueled rally in the process.

"We were wrong," Morgan Stanley CIO Mike Wilson said in a note to clients seen by Insider.

"2023 has been a story of higher valuations than we expected amid falling inflation and cost cutting," he added.

Many analysts predicted stocks would have a disappointing 2023 at the start of this year, with the Federal Reserve still hiking interest rates and economists fretting about a potential recession.

But the asset class has performed far better than they expected thanks to cooling inflation and the rise of artificial intelligence, with the benchmark S&P 500 index up 18% year-to-date.

Wilson remains downbeat on stocks despite failing to call that rally.

By June 2024, his team expects the S&P 500 to fall to 4,200 points – around 8% below the level it traded at as of Monday's closing bell.

The Morgan Stanley strategist warned rapidly falling inflation could soon start to drag down – rather than boost – equities, by chipping away at listed companies' nominal revenue and earnings.

"We believe inflation is now falling even faster than the consensus expects, especially the inflation received by companies," he wrote in Monday's note.

"With price being the main factor that has held sales growth above zero for many companies this year, it would be a material headwind if that pricing power were to roll over."

Wilson also called for some caution on AI, which has powered "Magnificent Seven" Big Tech stocks like Nvidia and Microsoft to massive gains in 2023.

While the bank sees the theme as a $6 trillion investing opportunity, the strategist warned it won't give companies' enough of an immediate earnings boost to outweigh disinflation and slumping growth.

AI "has provided a very constructive theme for investors to adopt," Wilson said. "In addition to the clear winners like Nvidia and Microsoft, many investors are getting excited about the longer-term productivity benefits from such technologies."

"While we share [the] excitement, we also believe it is premature to extrapolate such benefits across the entire economy and company earnings for this year, particularly given we are still facing growing risk of cyclical headwinds," he added.