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In bear markets, stocks don’t typically fall in a straight line.

Over the past 50 years, even in the worst financial crises of the modern era, brief rallies have occurred 6.5 times on average per bear market.

Unsurprisingly, this year has been no different. But all along the way, Morgan Stanley’s chief investment officer and U.S. equity strategist Mike Wilson has warned investors not to fall into these “bear market traps.”

And even after a more than 20% drop in the S&P 500 this year, Wilson—who received the nod as the world’s top stock strategist in the latest Institutional Investor survey—believes stocks will fall even further. Investors have been too focused on the Federal Reserve’s rate hikes and inflation, he argues, when the real problem is fading economic growth and corporate earnings.

“The earnings recession by itself could be similar to what transpired in 2008/2009,” Wilson wrote in a Monday research note. “Our advice—don’t assume the market is pricing this kind of outcome until it actually happens.”

Wilson believes that the S&P 500 will sink to between 3,000 and 3,300 in the first quarter of 2023 from roughly 3,800 today. And by the end of next year, he expects the index will recover to just 3,900—or even 3,500 in a “bear case.”

But despite recent economic doomsday predictions by Wall Street for a recession that is “double the normal length” or even “another variant of a Great Depression,” Wilson said that the economy will likely weather rising interest rates and high inflation, or at a minimum avoid a “balance sheet recession” and “systemic financial risk.”

For investors, on the other hand, the strategist offered a chilling warning: “[P]rice declines for equities will be much worse than what most investors are expecting.”

A flashback to August 2008?

In his Monday note, Wilson said that investors are making the same mistake they did in August of 2008—underestimating the risk that corporate earnings will fall.

“We bring this up because we often hear from clients that everyone knows earnings are too high next year, and therefore, the market has priced it,” he wrote, referring to optimistic earnings forecasts. “However, we recall hearing similar things in August 2008 when the spread between our earnings model and the street consensus was just as wide.”

For some background, by mid-August 2008, the U.S. economy was already in a recession and the S&P 500 was down 20% on the year to around 1,300. Many investors began to think the worst of the bear market was over, but then the bottom fell out as corporate earnings sank.

By March of the following year, the blue-chip index was sitting at just 683. Wilson created a chart comparing some key stock market stats from August of 2008 to today in his note.

In it, he pointed to the fact that the S&P 500, currently, is still richly valued by investors. In August of 2008, it was trading at roughly 13 times earnings, but today it’s up to 16.8 times.

Back then, the Federal Reserve had also already slashed interest rates by 3.25% in an effort to rescue the U.S. economy from what would later be known as the Great Financial Crisis.

Today it plans to continue raising rates and keep them high to fight inflation. Wilson said that this time “the Fed’s hands may be more tied” by high inflation, meaning it is less able to rescue stocks through rate cuts if a recession does occur.

Year-over-year inflation, as measured by the consumer price index, was 5.3% in August 2008, compared to 7.1% today.

Wilson doesn’t believe stocks will experience as big a drop as they did in 2008 because the housing market and banking system are in a better place, but he still expects the S&P 500 to fall to new lows for this downturn.

And even if a recession is avoided, it may not be a good thing for investors.

“While some investors may take comfort in that fact as a signal we may avoid an economic recession next year—i.e., a ‘soft landing,’ we would caution against that outcome for equity investors because in our view it simply means there is no relief coming from the Fed even as earnings forecasts are cut,” Wilson wrote.

Throughout 2022, many equity investors have been hoping inflation would come down, allowing the Fed to pause its interest rate hikes or even pivot to rate cuts. But Wilson argues earnings will suffer as inflation fades because U.S. corporations were able to increase their profits by raising prices and passing on extra costs to consumers.

“Rates and inflation may have peaked but we see that as a warning sign for profitability, a reality we believe is still under-appreciated but can no longer be ignored,” he wrote on Monday, adding that the “earnings outlook has worsened” in recent months.