A recession could crater the S&P 500 by more than 20% to 3,000, and the market downturn is already worse than expected, Morgan Stanley says

• The economic downturn is worse than expected, but there could be more downside ahead, Morgan Stanley said Tuesday.
• A recession could send the S&P 500 more than 20% lower to 3,000 this year, analysts said.

The current economic downturn is already worse than expected, but there's still more downside ahead for the market, according to Morgan Stanley.

Analysts led by Mike Wilson wrote in a Tuesday note that the stock market may not yet be sure what to make of falling bond yields. But yields still appear to be lagging economic data that's coming in worse than expected.

"In other words, the risk of growth slowing more than expected has only increased," according to the note.

The purchasing managers index from the Institute of Supply Management has been falling this year and points to continued declines, analysts added. If the economy slips into a recession, which is Morgan Stanley's bear case, then the PMI would fall to the low 40s, suggesting the S&P 500 would hit 3,000 late this year, more than 20% below current levels.

War in Ukraine and China's extended COVID-19 lockdowns have made the economy worse than forecasted, and now analysts expect earnings to play a significant role in what happens next in the stock market.

There are signs that profit expectations will be slashed in the coming months, the analysts said. Based on its earnings views, Morgan Stanley said a fair value for the S&P 500 would be about 3,400 to 3,500, or about 11% below current levels.

"Until earnings estimates are cut to more reasonable levels or valuations reflect that risk, the bear market is not complete," they said.