Market upheaval widens rift between Wall Street’s sunny and gloomy forecasts

Wall Street’s top forecasters are starting to develop diverse views on the state of the U.S. economy and the stability of the nation’s major stock indexes.

BlackRock, Morgan Stanley and Goldman all penned notes over the holiday weekend encouraging — or warning — clients on investing in the stock market after this month’s upheaval and in the face of massive fiscal stimulus and infrastructure spending.

The barrage of new views coincides with a ballooning federal deficit and fiscal stimulus, with anticipated debt and inflation prompting divergent calls from top strategists.

Morgan Stanley’s Mike Wilson, who was one of the Street’s most bullish strategists in 2017, is now its most bearish, according to CNBC’s Market Strategist Survey. At the same time, BlackRock has flipped its view and is now more bullish than a few months ago.

As the world’s largest money manager, BlackRock has quickly changed its tune on domestic equities. Kate Moore, BlackRock’s chief equity strategist, told investors that “the fundamental story is the best it’s been, which is surprising given how far we are into this cycle.”

“We remain very constructive on equities in general,” said Moore. “The U.S. just got an injection of stimulus that no place else in the world did.” The strategist said that while she was positive on top-line results before the Republican tax cut, the legislation has “supercharged” the results.

“What happened to the U.S. on the back of tax cuts and fiscal stimulus is something we’ve never observed,” she added. BlackRock is now overweight U.S. equities and neutral on European stocks.

Morgan Stanley strategists, however, were less enthused.

Andrew Sheets, chief cross-asset strategist at Morgan Stanley, told clients on Monday that the stock market’s recent 10 percent drop wasmerely an “appetizer, not the main course.”

Sheets argued that rising equity prices, rising inflation, tightening policy and higher commodity prices are all indicative of an old bull market.

“Inflation, after all, often plays a role in a late-cycle volatility rise, as there’s tension between still-strong current conditions, and the effect of tightening,” Sheets added. “At present, the strength of current data is still acting as a counterweight.”

The 10-year U.S. Treasury note yield rose to a four-year high last week, while the short-term two-year yield reached its highest level since 2008 on Tuesday.

Wilson, Morgan Stanley’s chief strategist, is the most bearish strategist on the Street with a 2,750 December target for the S&P 500, roughly 1 percent above its current level.

Meanwhile, Goldman Sachs Chief Economist Jan Hatzius warned that U.S. spending could push up rates and debt levels to dangerous heights.

“Federal fiscal policy is entering uncharted territory,” Hatzius wrote. “Congress has voted twice in the last two months to substantially expand the budget deficit despite an already elevated debt level and an economy that shows no need for additional fiscal stimulus.”

The economist added that the federal deficit should reach 5.2 percent of gross domestic product by 2019 and continue to gradually climb. The fiscal expansion, Hatzius wrote, may bolster GDP growth in 2018 and 2019, “but will likely come to an end after that” because growth effects are derived from changes in the deficit, not persistent levels.

Hatzius also notes, with tax cuts representing one of the Republican Party’s only major victories in 2017, the GOP is relying on it to shield them from a souring public come November’s midterm elections. But with a “good chance” control of Congress changes hands, it may be difficult to expand the deficit further, according to Hatzius.

— CNBC’s Patti Domm, Javier David and Fred Imbert contributed to this report.

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