Speaker 1: Firmly focused on stocks.
Speaker 2: He's one of the last bears remaining down on Wall Street.
Speaker 2: Morgan Stanley's CIO and chief US equity strategist, Mike Wilson
Speaker 2: joins us at the desk this morning, and Mike's great
Speaker 2: to have you to kick off the program. Thanks so
Speaker 2: much for coming in to be our first guest. What
Speaker 2: do you think about the valuations? I showed just a
Speaker 2: moment ago if you type e c SU on the
Speaker 2: Bloomberg term release THEE economic surprises and they continue to
Speaker 2: come out to the downside.
Speaker 3: Yeah.
Speaker 4: Look, we're in this period where bad is good for multiples, right,
Speaker 4: So slower growth, as long as it's not a recession,
Speaker 4: brings down inflation expectations, which allows the FED to cut
Speaker 4: and that's what the market has been anticipating now for
Speaker 4: almost a year now. They've been wrong about the number
Speaker 4: of cuts. But the conclusion the equity market is making
Speaker 4: right now is that, well, there's not going to be
Speaker 4: a hike, and we know the direction of travel is down.
Speaker 4: That's fine, so long as that negative growth surprise doesn't
Speaker 4: turned into a hard landing, and right now that's not
Speaker 4: the case. Now the labor market is showing signs of weakness,
Speaker 4: but not to the degree that would freak out equity markets.
Speaker 4: And what's going on is the markets that are very
Speaker 4: efficient right now, they're basically putting money to work in
Speaker 4: high quality growth stocks. They're paying up for anything that
Speaker 4: has growth because that's what the market needs. Growth is scarce,
Speaker 4: so you know, people are saying, well that market share
Speaker 4: broad it's not going to broaden out that this continues.
Speaker 4: But it also doesn't mean that we're going to collapse
Speaker 4: until there's either evidence that we're going to be hard
Speaker 4: landing or there's evidence that we're going to reaccelerate, and
Speaker 4: then the FED can't cut and rates go higher.
Speaker 3: So we're stuck.
Speaker 4: We're stuck in this sort of environment that really a
Speaker 4: lot of active managers don't like because it's narrow. It's
Speaker 4: hard to pick stocks again, and it's hard.
Speaker 1: To outperform, hard to outperform.
Speaker 5: It sounds like what you're saying, though, is that at
Speaker 5: the benchmark level that narrow breath, it doesn't necessarily mean
Speaker 5: that it returns will be waged down.
Speaker 4: No, not necessarily, And we did some work on this
Speaker 4: the last couple of weeks. It shows that when breath
Speaker 4: is this bad, and by the way it's historically bad,
Speaker 4: it's a fifty to fifty chance that it's bad, and
Speaker 4: it's fifty to fifty chance that it's good for the
Speaker 4: overall SMP five hundred index. And so we play this
Speaker 4: game until it ends in the game will change. The
Speaker 4: question is is it going to be a situation where
Speaker 4: you have everything gets corrected lower or can it broaden
Speaker 4: out to small caps, to more cyclical stocks, to other
Speaker 4: assets that you don't have a multiple forty fifty times Mike.
Speaker 6: You've written recently also that investors are increasingly becoming concerned
Speaker 6: about higher rates, perhaps even a rate hike down the corner.
Speaker 6: You look at this year and expectations for September, for example,
Speaker 6: but then you look on a longer horizon and the
Speaker 6: worries about fiscal spending here spending from either a future
Speaker 6: Biden administration or a future Trump administration. How much worry
Speaker 6: do investors really have under the surface and how could
Speaker 6: that throw the entire storyline off course?
Speaker 3: Right now?
Speaker 4: That concern is not there, okay, And the way we
Speaker 4: measure that concern is the term premium. So rates have
Speaker 4: gone up this year from January, and it didn't affect
Speaker 4: the overall market multiples because it was not about term premium,
Speaker 4: meaning concern about fiscal prompt you know, sort of spending.
Speaker 4: It was about growth being better and frankly, inflation being better.
Speaker 4: Now there's a misnomer out there that higher inflation is
Speaker 4: bad for stocks.
Speaker 3: Not true.
Speaker 4: Higher inflation is good for smaller stocks, it's good for
Speaker 4: the average stock. What we have right now is we
Speaker 4: have a disinflationary boom, which really means that.
Speaker 3: The few stocks benefits.
Speaker 4: So I don't think it's a risk now, but with
Speaker 4: our election, with the elections overseas that are going on,
Speaker 4: and one pointly just the fiscal spending that's going on,
Speaker 4: regardless of the outcome of the elections, I think it
Speaker 4: could come back into play later this year. One thing
Speaker 4: we're watching very closely is how they're funding the government. Okay,
Speaker 4: so we have the reverse repo, which is pretty well
Speaker 4: understood at this point.
Speaker 3: It's about four to four hunred and.
Speaker 4: Fifty billion dollars that they can They can use that
Speaker 4: to fund bill issuance.
Speaker 3: Effectively, they still have a.
Speaker 4: Fairly large Treasury General account, so if they need to
Speaker 4: tap into that because they don't want to issue as
Speaker 4: much paper. They can do that, and then and they
Speaker 4: still have you know, the FED, which is going to
Speaker 4: start curtailing QT now, which is effectively QE, right, if
Speaker 4: they start reinvesting, which is what the end of QT is,
Speaker 4: that's about you know, six seven hundred billion dollars annually
Speaker 4: of bond purchases, So they have the liquidity provisions in
Speaker 4: place at least to the end of the year, I
Speaker 4: would argue, and then we'll see, So twenty five could
Speaker 4: be a bigger challenge for that term premium.
Speaker 1: Do they have to go the other way? Does the
Speaker 1: FED have to go the other way?
Speaker 2: If Trump wins in November, because he's talking about massive
Speaker 2: tariffs on the Chinese, he's talking about deporting millions of
Speaker 2: people from the US obviously shutting down the border. That's
Speaker 2: all incredibly inflationary, right, or it could be, at least
Speaker 2: according to Larry Summers.
Speaker 3: Yeah, it could be.
Speaker 4: I think the FED is going to be patient on
Speaker 4: that because look, I mean, these things all lag. Even
Speaker 4: if those things happen, it won't take place until the
Speaker 4: first second quarter of next year, and then the impact
Speaker 4: on the actual data will be a year from now.
Speaker 4: So I think the FED is probably going is on
Speaker 4: track now. I think they want to cut rates. They
Speaker 4: want to cut rates more than twenty five or fifty
Speaker 4: because the curve is inverted by a significant amount, So.
Speaker 1: The twenty five basis points doesn't do a lot.
Speaker 4: I don't think twenty five to fifty basis points change.
Speaker 4: Is this dynamic that we're seeing in the equity market,
Speaker 4: meaning the kind of scarcity of growth paying up for
Speaker 4: growth in a way that we've been seeing. Now, if
Speaker 4: we were to get one hundred basis points to one
Speaker 4: hundred and fifty basis points of because without hard landing,
Speaker 4: then we could maybe see some rotation away from these leaders.
Speaker 1: Well, we'll see.
Speaker 5: Of course, so far the data hasn't even allowed them
Speaker 5: to do twenty five basis points, so we'll see if
Speaker 5: that starts to cooperate.
Speaker 1: I do want to talk about.
Speaker 5: Earning Season because in addition to the show launch, we
Speaker 5: also do have Earning Season kick off this week, and
Speaker 5: I was taking a look. If you take a look
Speaker 5: at expectations for twelve month forward earnings, they're at all
Speaker 5: time highs right now. I mean, how high is the
Speaker 5: bar for corporate America and can it actually meet that?
Speaker 4: Essentially an interesting kind of observation, because the reality is, yes,
Speaker 4: forward twelve month numbers are going up, but they're going
Speaker 4: up because we're moving out in time.
Speaker 3: And I would argue that.
Speaker 4: Twenty twenty five estimates are no one's even really done
Speaker 4: the math on that. No one has really actually calculated two.
Speaker 4: No one's estimating twenty twenty five. All they're doing is
Speaker 4: estimating the next two quarters and then rolling forward to
Speaker 4: some sort of growth rate. So I would argue that
Speaker 4: earning vestment has been coming down on a quarterly basis,
Speaker 4: Like for the last eighteen months, each coreter gets revised lower,
Speaker 4: they jump over the lowered bar. And that's exactly how
Speaker 4: we're set up for this quarter again, which is that
Speaker 4: earning has been coming down.
Speaker 3: They'll probably meet the expectations beat them.
Speaker 4: And this is where I think we could start to
Speaker 4: see twenty five estimates come down. Typically in the second
Speaker 4: half of the year, the market and analysts start to
Speaker 4: look ahead and say, actually, twenty five, we're going to
Speaker 4: have to revise this. And the wild card is the
Speaker 4: starts with the fourth quarter of this year. That's the
Speaker 4: big hockey stick of expectations. That's where the expectations get challenging.
Speaker 4: And the question is can companies manage that in a
Speaker 4: smooth way between here and the end of the year.
Speaker 6: We were talking a little bit earlier about earning Ceason, Mike,
Speaker 6: and we have this situation where you have high hies,
Speaker 6: high expectations. How much can these companies start to deliver here?
Speaker 6: How much of an issue are they going to have
Speaker 6: if they don't well.
Speaker 4: I think this is one area where you know, once again,
Speaker 4: bad is bad, Okay, So I would argue that weaker
Speaker 4: economic data is potentially good for multiples generally, at least
Speaker 4: if you're delivering on the earnings. But if you have
Speaker 4: bad earnings reports, you're gonna get punished. And that's been
Speaker 4: consistent all year, which is why the average stock is
Speaker 4: down this year. The average company has not had good
Speaker 4: earnings results.
Speaker 2: That's a good point to make, Mike, by the way,
Speaker 2: because we talk about you know, Jess Metton from our
Speaker 2: equity team writes about this earnings expansion that we're in
Speaker 2: three quarters in a row of growth, but it's only seven, eight,
Speaker 2: maybe ten companies. The other four hundred and ninety in
Speaker 2: the S and P are not doing well. So what
Speaker 2: has to happen for them to grow?
Speaker 1: To increase their earnings to do well.
Speaker 3: Yeah.
Speaker 4: Well, first of all, it's more than seven companies, but
Speaker 4: it's not more than probably thirty or forty. So it's
Speaker 4: a narrow it's like a fifty to fifty on us
Speaker 4: is where I would characterize it. Now, what needs to
Speaker 4: happen once again, We need the FED to cut like meaningfully.
Speaker 4: We need a curve to re steep in. We need
Speaker 4: cost to capital we come down. We need the labor
Speaker 4: markets to loosen up in a way where you know,
Speaker 4: over these smaller businesses can actually hire people at a
Speaker 4: reasonable price. Any pricing power to come back. One thing
Speaker 4: that gets overlooked is companies are losing pricing power now.
Speaker 4: So while we're all rooting for lower inflation once again,
Speaker 4: weaker inflation is not great for earnings. You know, small
Speaker 4: cap businesses, small cap companies like Brussel two thousand typically
Speaker 4: only does well coming out of a recession coming out
Speaker 4: of a new cycle. Why because race are low, curve
Speaker 4: is fully steepened, access to capital is abundant, and they
Speaker 4: have operating leverage.
Speaker 3: Again, that's just not where we are.
Speaker 4: So we need races to come down as number one,
Speaker 4: or we need some sort of exogenous positive shock on
Speaker 4: the growth side that doesn't lead to an inflationary problem.
Speaker 3: So you tell me where that's coming from.
Speaker 4: I think it's going to be a chance to challenge,
Speaker 4: and that's why we're not going to fight this trend.
Speaker 4: I mean, the momentum is so strong, because it's right now.
Speaker 4: What worries me is that that momentum is so strong
Speaker 4: and people have a lot more exposure to high multiple
Speaker 4: stocks than they think they do, and if you have
Speaker 4: an event that's unpredictable, then you could have a real
Speaker 4: reset on evaluation of ten to fifteen percent. I think
Speaker 4: the chance of a ten percent correction is highly likely
Speaker 4: sometime between now and the election, not just because of
Speaker 4: the election, but because uncertainty is going to prevail for
Speaker 4: a lot of different reasons. Earnings reasons, you know, election
Speaker 4: outcome reasons, some of the things you mentioned earlier on
Speaker 4: taris potentially immigration, fed policy still remains uncertain.
Speaker 3: So yeah, I think the third quarter typically is that
Speaker 3: period and it is going.
Speaker 4: To be chopping now. We're hopefully that's going to create
Speaker 4: some opportunity. But like right here, evaluations to me like
Speaker 4: very very unexciting.
Speaker 5: And it's a great point too, on you might be
Speaker 5: more exposed to tech than you think, especially if you're
Speaker 5: sitting in the S and P five hundred, which is
Speaker 5: what thirty percent tech or so I do want to
Speaker 5: actually talk about how all this rolls into price targets.
Speaker 5: And typically at this point I would ask you what
Speaker 5: your year end S and P five hundred forecast is.
Speaker 5: But I know that you've backed away from those sorts
Speaker 5: of calls. And it was interesting if you take a
Speaker 5: look at Friday, we got some news from Piper Sandler
Speaker 5: saying that they're actually going to drop their S and
Speaker 5: P five hundred forecasts, that basically it's bad practice. And
Speaker 5: when you think about that, I mean, are we starting
Speaker 5: to see the beginning of the end of these big
Speaker 5: bold S and P five hundred forecasts?
Speaker 4: Well, no, what we did is we rolled forward to
Speaker 4: our forecast twelve months in May, so we take away
Speaker 4: our year end target and look, the first thing I
Speaker 4: would say is S and P targets at a certain
Speaker 4: time and price is kind of silly. But what I
Speaker 4: would tell you is that the risk reward from here,
Speaker 4: we think is lower, like over the next four to
Speaker 4: six months, for the same reason I just mentioned, we
Speaker 4: have volatility probably picking up in the third quarter. I
Speaker 4: would say you're upside your luckihood of upset between now
Speaker 4: and your end is very low, much lower than normal.
Speaker 4: I'd call it twenty twenty five percent. That markets are
Speaker 4: higher between now and year end. Okay, specific target, I
Speaker 4: don't know, but let's say it's down ten percent or so.
Speaker 3: Then we would get interested.
Speaker 4: Then we'd be interested to say, Okay, maybe there's some
Speaker 4: things happening at the index level. Where the opportunity remains
Speaker 4: is at the stock level, at the factor level. Okay,
Speaker 4: And in that regard, we still like sort of growth,
Speaker 4: but not just quality quality growth, but like you know,
Speaker 4: quality in general, archcap, good balance sheets, companies that can
Speaker 4: deliver on earnings, and that momentum will continue. It's just
Speaker 4: hard to find companies that are cheap. So if they
Speaker 4: were to come in ten percent, then we probably get
Speaker 4: interested in Hey.
Speaker 6: Mike Elfin in the room here, theory of strategy, you
Speaker 6: just lost your perhaps your biggest competitor on wall streets
Speaker 6: had stepped down from his post at JP Morgan. Does
Speaker 6: that put pressure on you to really move forward with
Speaker 6: cautionary tales?
Speaker 1: Here?
Speaker 6: There are just fewer bears on Wall Street.
Speaker 4: Yeah, I mean, and look, I would say we kind
Speaker 4: of you know, pivoted on that already the beginning of
Speaker 4: the year. We sort of moved away from being too bearish.
Speaker 4: But at the end of the day, it's a tough gig,
Speaker 4: you know, I mean, trying to predict, you know, once
Speaker 4: again S and P five hundred certain And that's not
Speaker 4: an excuse. That's what we get paid to do. Sometimes
Speaker 4: we get it right, sometimes we get it wrong. And look,
Speaker 4: doesn't put any pressure. IM going to do my job
Speaker 4: any different, right, just like being wrong doesn't make me
Speaker 4: feel pressure. Oh but now I have to change my
Speaker 4: view completely. The way we get paid by clients, institutional
Speaker 4: clients is to give them a good analysis, a good framework,
Speaker 4: so that they can make their decisions on how I
Speaker 4: should be investing in.
Speaker 3: That process will never change.
Speaker 1: Well, you've done that for us, so we really appreciate
Speaker 1: you coming in, Mike. Thanks so much. Mike Wilson.
Speaker 2: There Morgan Stanley's CIO and chief US Equity Strategies