3 Risks That Could Derail U.S. Stocks

Apr 18, 2023

Cracks in the labor market, worsening business conditions and weak corporate earnings bode ill for equities.

Lisa Shalett

Key Takeaways

  • U.S. stock investors appear overly optimistic about the health of the economy and corporate earnings.
  • Signs of weakness in the labor market, deteriorating business conditions and lower earnings estimates are causes for concern.
  • Investors should focus on income and yield opportunities.

With stocks continuing to post gains into the second quarter—marked by an 8% rise in the S&P 500 Index this year—bullish equity investors appear full of optimism. They seem to believe that inflation has been tamed, the Federal Reserve is nearly done raising interest rates and will soon begin to cut, and that corporate earnings will be resilient.


This rosy outlook underpins today’s very rich equity valuations but likely leaves little room for any “upside,” or the potential for further gains, and more important, may set up equity investors for disappointment.


We believe the market’s resilience overlooks the growing risk of an economic recession as the Fed comes to the final stages of its rate-hiking cycle. Here are three risks investors should watch:

  1. 1
    The labor market is starting to show cracks.

    March’s nonfarm payroll employment data highlighted a better-than-expected gain of 236,000 jobs, labor-force participation on the rise and an unemployment rate near a record low. However, the Job Openings and Labor Turnover Survey (JOLTS) showed the biggest drop in job openings over three years, with postings falling below 10 million in February. Initial unemployment claims are also edging higher as small businesses slow their hiring, job-cut announcements rise and consumer sentiment falls. 

  2. 2
    Bank lending is slowing, and business conditions may be worsening.

    The two weeks ending March 29 saw the largest decline in loans and leases at commercial banks in nearly 50 years. In a recent National Federation of Independent Business (NFIB) survey, 9% of small businesses reported that financing was harder to get than three months ago, the highest rate since December 2012. Also consider corporate bankruptcy data: Following multi-decade lows in 2022, bankruptcy filings in the first three months of 2023 were the most in any first quarter since 2010.

  3. 3
    Companies are lowering their first-quarter performance forecasts.

    According to FactSet, 78 companies have cut first-quarter estimates already, the most since the third quarter of 2019. Many of these trimmed outlooks are coming from the tech and industrials sectors. Investors’ expectation that first-quarter results will mark the worst of this economic cycle—even before we’ve seen a true slowdown in the economy or an uptick in unemployment—seems naïve.

It should be no surprise to investors that one of the most severe monetary policy tightening campaigns in 40 years is now beginning to weigh on the economy. Investors should pay attention to first-quarter corporate earnings results and performance forecasts from company management, which may point to a slowdown ahead.


Investors deploying new cash should focus on income and yield opportunities in both stocks and bonds. Many equity bulls point to “cash on the sidelines” as a reason that stock prices may yet edge higher. But with valuations rich and cash-like instruments offering yields of 4­–6%, stocks—especially market-cap-weighted index funds—look less compelling.


This article is based on Lisa Shalett’s Global Investment Committee Weekly report from April 17, 2023, “Bad Is Now Bad.” Ask your Morgan Stanley Financial Advisor for a copy. Listen to the audiocast based on this report.

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