WEBVTT - Morgan Stanley Chief US Equity Strategist Mike Wilson Talks Fed Rate Cuts 0:00:02.520 --> 0:00:07.280 Bloomberg Audio Studios, podcasts, radio news. 0:00:07.760 --> 0:00:09.280 Mike, Good morning, sir, Morning John. 0:00:09.320 --> 0:00:10.680 I want to pick up on I think a coal 0:00:10.800 --> 0:00:13.399 view of yours for twenty twenty five coming into twenty 0:00:13.400 --> 0:00:16.799 twenty six, recessions behind us. I think that's somewhat unique 0:00:16.920 --> 0:00:18.720 to you and a team at Morgan Stanley just built 0:00:18.720 --> 0:00:19.400 that out for us. 0:00:19.720 --> 0:00:21.360 Yeah, I mean, you know, we try to work six 0:00:21.360 --> 0:00:23.000 months in the future. I think in a year ago. 0:00:23.079 --> 0:00:25.040 I think remember we had this conversation after the election. 0:00:25.120 --> 0:00:27.600 You were saying, make you sound more optimistic than I've 0:00:27.600 --> 0:00:29.000 heard you in a while, and it was kind of 0:00:29.000 --> 0:00:29.360 we were. 0:00:29.240 --> 0:00:30.440 Thinking six months in advance. 0:00:30.480 --> 0:00:32.559 We thought the first half would be tough as they 0:00:32.600 --> 0:00:35.280 transitioned from the kind of growth negative policies. 0:00:34.840 --> 0:00:36.199 To these growth positive policies. 0:00:36.240 --> 0:00:38.960 All this capex you're talking about is right in line 0:00:39.000 --> 0:00:41.000 with the big beautiful bill. I mean, they're trying to 0:00:41.000 --> 0:00:45.040 basically reduce consumption increase investment. Okay, it's a totally different economy. 0:00:45.200 --> 0:00:48.400 And what that is, it's a higher velocity economy. For 0:00:48.560 --> 0:00:50.479 all the companies that haven't been doing well for the 0:00:50.560 --> 0:00:52.400 last I would say three years, we've been sort of 0:00:52.400 --> 0:00:53.080 in a recession. 0:00:53.600 --> 0:00:54.440 I would argue strong. 0:00:54.520 --> 0:00:56.240 We've done the work on this, and you know, we've 0:00:56.320 --> 0:00:59.360 done analysis with respect to the rolling recession that has 0:00:59.400 --> 0:01:01.440 been in place or I would say three years, most 0:01:01.440 --> 0:01:03.880 of the privatey, economy kind of suffering, government kind of 0:01:03.920 --> 0:01:06.400 carrying the water, and then we basically saw all of 0:01:06.440 --> 0:01:09.400 that come to fruition at the end in April. April 0:01:09.440 --> 0:01:12.320 capitulation day as I call it, was basically the government 0:01:12.360 --> 0:01:15.240 recession that was the final piece of the rolling recession. 0:01:15.520 --> 0:01:17.600 And if you actually look at the Challenger job cuts 0:01:17.760 --> 0:01:19.520 and you look at the revision data now on the 0:01:19.560 --> 0:01:22.480 on the NFL, on the payroll data, it clearly looks 0:01:22.480 --> 0:01:24.880 to me like a rate of change low okay in 0:01:24.920 --> 0:01:27.720 payrolls and a rate of change high in Challenger job 0:01:27.760 --> 0:01:30.160 cuts came in April. So the markets figured all this out, 0:01:30.160 --> 0:01:31.800 and that's why revision breath has gone straight up. 0:01:31.880 --> 0:01:34.479 So rolling recovery, where are we that strges? 0:01:34.600 --> 0:01:37.480 So we deemed at the rolling recovery in April, and 0:01:37.520 --> 0:01:39.800 we're now seeing that, like these areas of the marketer, 0:01:40.120 --> 0:01:42.000 not everything's going to recover it once, because it's a 0:01:42.080 --> 0:01:45.040 it's an unorthodox recession. It's not like everything flushed at 0:01:45.080 --> 0:01:47.240 once and everything recovers at once, So it is going 0:01:47.280 --> 0:01:49.200 to be staged, and we've seen it in the market. 0:01:49.280 --> 0:01:52.280 We're still narrow quite frankly, AI campbex Is still is 0:01:52.560 --> 0:01:55.160 kind of one of early recoveries here, semiconductors being an 0:01:55.160 --> 0:01:57.600 early cycle group. But we're not seeing the other quote 0:01:57.680 --> 0:02:01.040 unquote early cycle groups recover the way they typically do 0:02:01.200 --> 0:02:04.240 in a new economic cycle. Why because the FED is 0:02:04.240 --> 0:02:06.120 behind a curve. The FED is way behind a curve 0:02:06.160 --> 0:02:08.760 on rates. They need rates much lower if you really 0:02:08.800 --> 0:02:11.480 want to get the private economy moving, rates are too high. 0:02:11.560 --> 0:02:13.640 Much lower? How much lower do you think that really 0:02:13.680 --> 0:02:15.119 is required to get that broadening out? 0:02:15.160 --> 0:02:17.280 Well, let's just start with the two year treasury yield. 0:02:17.360 --> 0:02:20.120 Okay, So my barometer is always the FED is behind 0:02:20.160 --> 0:02:24.280 the curve. If FED funds is above two year treasury yields, 0:02:24.360 --> 0:02:26.680 and in order to stimulate the private economy, I would 0:02:26.680 --> 0:02:28.000 say they need to be well below that. 0:02:28.240 --> 0:02:29.080 So that's fifty. 0:02:28.800 --> 0:02:31.000 Basis points just to get the neutral and maybe another 0:02:31.000 --> 0:02:33.799 one hundred plus to get to something that's more stimulative 0:02:33.800 --> 0:02:35.760 for the average company and the average consumer. 0:02:35.919 --> 0:02:39.280 Are you right now betting on that broadening out and 0:02:39.320 --> 0:02:43.760 expecting maybe AI to underperform going forward as they invest 0:02:43.880 --> 0:02:47.560 more in some of these debt sales and the infrastructure 0:02:47.639 --> 0:02:50.440 side and the rest of the economy plays catch up. 0:02:50.520 --> 0:02:53.160 Absolutely, think about the trickle down effect of this capital spending. 0:02:53.240 --> 0:02:55.480 I mean, it's not just going to be semi conunter companies. 0:02:55.480 --> 0:02:58.040 There's a lot of infrastructure, there's a lot of job creation, 0:02:58.080 --> 0:03:00.320 there's a lot of velocity in a real economy, and 0:03:00.360 --> 0:03:03.360 the lending channels starts getting going, perhaps for small medium 0:03:03.400 --> 0:03:06.480 businesses that job creation. Deregulation is another part of that story. 0:03:06.680 --> 0:03:08.079 Okay, so absolutely that's. 0:03:07.960 --> 0:03:11.160 What should happen if things play out the way they could. 0:03:11.320 --> 0:03:12.480 Now there's risk to that. 0:03:12.720 --> 0:03:15.160 Let's say that FED continues to say, hey, we still 0:03:15.160 --> 0:03:18.520 think there's inflation risk, we don't like the inflationary three percent, 0:03:18.560 --> 0:03:21.680 we're not going to raise our targets there, and then 0:03:21.680 --> 0:03:22.760 we just kind of drag their feet. 0:03:22.800 --> 0:03:23.639 It's going to stay narrow. 0:03:23.720 --> 0:03:25.600 Then it's going to stay up the quality curve, and 0:03:25.639 --> 0:03:27.440 that's where we are right now. He says that people 0:03:27.480 --> 0:03:30.799 basically are trying to choose between those two outcomes, and 0:03:30.800 --> 0:03:33.240 I would say right now, most institutional community is still 0:03:33.360 --> 0:03:36.120 huddled into the high quality stocks. They haven't really made 0:03:36.160 --> 0:03:39.360 the transition yet. Well, we have in some of our guidance. 0:03:39.400 --> 0:03:39.560 Yeah. 0:03:39.560 --> 0:03:42.240 Absolutely, In order for that transition to work, the FED 0:03:42.320 --> 0:03:43.000 has to cut though. 0:03:43.200 --> 0:03:44.440 That's what it's contingent on. 0:03:44.960 --> 0:03:46.920 It's one of the main things now. Drag is a 0:03:46.920 --> 0:03:49.040 big part of that. Okay, the capital spending is a 0:03:49.080 --> 0:03:52.160 part of that. Those can happen without the FED cutting significantly, 0:03:52.360 --> 0:03:54.440 but it would really, it would really solidify it for me. 0:03:54.480 --> 0:03:55.600 And if you go back and look at all these 0:03:55.640 --> 0:04:00.680 different economic cycles, small caps and lower quality stocks typically 0:04:00.760 --> 0:04:03.800 don't outperform until the FED gets below two year treasury heels. 0:04:03.800 --> 0:04:05.920 We've we've documented this, so by the way, it doesn't 0:04:05.920 --> 0:04:08.240 mean these stocks can't work in absolute terms. It just 0:04:08.280 --> 0:04:11.360 means that relative outperformers you typically get in that early 0:04:11.400 --> 0:04:14.640 cycle rotation needs FED funds to be much lower. 0:04:14.840 --> 0:04:16.480 If you look at the FED next year, are you 0:04:16.600 --> 0:04:19.880 just expecting a federal reserve that's markedly different than it 0:04:19.960 --> 0:04:21.120 was today than it is today? 0:04:21.360 --> 0:04:23.160 Well, I think they're just I think they're being patient here, 0:04:23.680 --> 0:04:25.800 They're doing their job. I'm not wanting to sit here 0:04:25.800 --> 0:04:27.240 and criticize the Fed left and right. 0:04:27.240 --> 0:04:29.480 What I see is just a very. 0:04:29.240 --> 0:04:32.920 Weird economic cycle, and I think we've kind of we've 0:04:32.920 --> 0:04:34.640 solved the puzzle a little bit on this, and that's 0:04:34.680 --> 0:04:37.240 why I feel fairly confident that our narrative we laid 0:04:37.279 --> 0:04:38.280 out this year is played out. 0:04:38.320 --> 0:04:38.520 Now. 0:04:38.520 --> 0:04:41.120 I'm getting evidence in the marketplace, and I feel more 0:04:41.120 --> 0:04:43.400 confident in that narrative. And that's sort of the difference. 0:04:43.400 --> 0:04:45.279 I just think they're not there yet, you know, they're 0:04:45.320 --> 0:04:47.240 not where I am in my head. I could be wrong, 0:04:47.279 --> 0:04:48.880 but I'm pretty confident about that outcome. 0:04:48.960 --> 0:04:50.040 Can we finish on big tench? 0:04:50.160 --> 0:04:50.440 Sure? 0:04:50.520 --> 0:04:53.680 These companies are changing. We're used to companies that weren't 0:04:53.680 --> 0:04:56.520 investing tons ultimately, that were giving it back to shareholders. 0:04:56.680 --> 0:04:58.520 Now we've seen a subtle twist I think from the 0:04:58.640 --> 0:05:01.320 likes of say Meta, who was spending tons and tons 0:05:01.400 --> 0:05:03.440 and tons and then coming to the debt market to 0:05:03.480 --> 0:05:06.039 fund it. That's not what we're used to with these 0:05:06.120 --> 0:05:09.279 names typically the asset like capital return heavy. Are you 0:05:09.320 --> 0:05:11.320 not seeing the same change? And how should we treat 0:05:11.320 --> 0:05:13.599 those companies differently of at all? Because of that? 0:05:13.920 --> 0:05:15.800 So let's talk about the risks for the bullmarket. 0:05:15.880 --> 0:05:18.320 We think a bull market started in April new economic 0:05:18.360 --> 0:05:19.080 earning cycle. 0:05:19.360 --> 0:05:20.360 Okay, there are two risks. 0:05:20.360 --> 0:05:23.360 One is it the FED drags their feed liquidity funding 0:05:23.360 --> 0:05:25.640 market stresses kind of pop up. The second one is 0:05:25.680 --> 0:05:27.520 what you just talked about, is that the market starts 0:05:27.520 --> 0:05:30.240 to push back on the fact that free cash flow 0:05:30.320 --> 0:05:32.880 growth is actually decelerating for some of these businesses and 0:05:32.920 --> 0:05:35.919 the asset light story is being called into question. 0:05:36.000 --> 0:05:37.679 We haven't seen it yeto the last week. 0:05:37.600 --> 0:05:40.880 Was the first sign we saw pretty diversion performance between 0:05:40.880 --> 0:05:43.719 some of these and that's a risk because if all 0:05:43.760 --> 0:05:46.640 of a sudden the market starts to become a governing factor 0:05:46.680 --> 0:05:49.520 on those stocks. I can guarantee you that the management 0:05:49.520 --> 0:05:51.039 teams are going to say, well, maybe we aren't going 0:05:51.080 --> 0:05:52.720 to spend quite as much, just like we saw in 0:05:52.720 --> 0:05:54.280 the fall of twenty twenty four as we talked about 0:05:54.279 --> 0:05:56.960 the deceleration and campex, and also we saw that with 0:05:58.160 --> 0:06:00.960 other times when these companies spend much money the market 0:06:01.080 --> 0:06:03.680 is a governing factor. The management change their view how 0:06:03.960 --> 0:06:05.919 how they're guiding on the campex. Right now, they're getting 0:06:05.920 --> 0:06:08.080 rewarded for more campex the market. 0:06:08.360 --> 0:06:10.080 Is it welcome news that they're leaning on the debt 0:06:10.120 --> 0:06:12.680 market a little bit more, just as a sequity market 0:06:12.720 --> 0:06:13.800 starts to push back. 0:06:13.720 --> 0:06:15.040 Well, I think that. I mean, I think it's a 0:06:15.120 --> 0:06:15.839 natural evolution. 0:06:16.080 --> 0:06:18.600 And and and just to be clear, in all these buildouts, 0:06:18.600 --> 0:06:22.760 whether it's railroads, electricity, uh, the internet itself, Okay, we 0:06:22.839 --> 0:06:24.920 got to get renown to the debt part. Okay, So 0:06:25.080 --> 0:06:27.320 now they just raised a ton of capital, Well, they're 0:06:27.320 --> 0:06:29.159 not going to sit They're going to spend it. So 0:06:29.440 --> 0:06:31.520 like that's another reason to be excited on one hand, 0:06:31.560 --> 0:06:33.360 because we know that money is going to get spent, 0:06:33.480 --> 0:06:35.800 not going to sit there and collect dust. So so 0:06:36.080 --> 0:06:38.520 you know, typically it could last a year, two three, 0:06:38.560 --> 0:06:40.680 I don't know, I mean, but it's hard for me 0:06:40.720 --> 0:06:42.520 to believe that the spending cycles. 0:06:42.120 --> 0:06:44.440 Over when they just raised gobs and gobs of dollars. 0:06:44.520 --> 0:06:47.280 Do you think it japanizes comportive term programs as these 0:06:47.320 --> 0:06:48.600 companies take on more leverage. 0:06:48.640 --> 0:06:50.520 Yeah, it's competing for the for the free cash flow. 0:06:50.560 --> 0:06:52.280 So whether it's camp and by the way, Capex now 0:06:52.320 --> 0:06:54.640 is a percentage of free cash flow is pretty high 0:06:54.680 --> 0:06:56.880 for these businesses. But once again, I want to go back, 0:06:56.920 --> 0:06:58.280 this is this is by design. 0:06:58.360 --> 0:06:59.080 Okay. 0:06:58.880 --> 0:07:03.240 The tax bill is basically incenting these companies to do it. Now, 0:07:03.320 --> 0:07:07.599 I mean, the government administration is really encouraging businesses of 0:07:07.640 --> 0:07:09.840 all types to start investing for the first time in 0:07:09.880 --> 0:07:13.520 fifteen years. We've underinvested in so many things, not just 0:07:13.640 --> 0:07:17.840 you know, AI, but like infrastructure and factories and you know, 0:07:17.920 --> 0:07:20.720 automating production and robotics and things like that. I mean, 0:07:20.720 --> 0:07:24.400 this bill is designed to get that engine of growth moving. 0:07:24.160 --> 0:07:26.640 And it's happening. It's just putting all these pieces together. 0:07:27.280 --> 0:07:29.240 This was a core theme, I think, a core pillar 0:07:29.280 --> 0:07:32.000 for being long US equities for a long long time. 0:07:32.440 --> 0:07:34.840 And now it's changed. Is it still good? I think 0:07:34.840 --> 0:07:36.080 that's what I'm trying to get out here. Is this 0:07:36.120 --> 0:07:37.680 still an argument to buying US ecrities. 0:07:37.760 --> 0:07:40.280 I think that the valuation, you know, is telling you 0:07:40.320 --> 0:07:41.920 that the growth is going to be better than we think. 0:07:41.960 --> 0:07:43.280 My view is that earning SC is going to be 0:07:43.280 --> 0:07:44.720 better next year than people expect. 0:07:44.760 --> 0:07:45.000 Now. 0:07:45.840 --> 0:07:47.480 On the other side of that, I do think we're 0:07:47.480 --> 0:07:49.520 in a different environment where we have these hotter but 0:07:49.600 --> 0:07:52.560 shorter cycles. Okay, so we're not in these ten year 0:07:52.640 --> 0:07:55.560 economic expansions anymore, and so it's two years on, one 0:07:55.600 --> 0:07:57.240 year off, two years on, one year off. That's what 0:07:57.240 --> 0:07:59.720 we've had since COVID right twenty twenty twenty twenty one good, 0:08:00.080 --> 0:08:02.240 twenty two bad, twenty three, twenty four good, twenty four 0:08:02.280 --> 0:08:02.800 to twenty. 0:08:02.560 --> 0:08:03.880 Five, and that's so good. Now we're into a new 0:08:03.880 --> 0:08:04.520 two year cycle. 0:08:04.520 --> 0:08:07.080 So you just have to understand that because inflation is 0:08:07.120 --> 0:08:09.280 right under the surface, and now you have a higher 0:08:09.360 --> 0:08:12.280 velocity economy that means you're going to have to trade 0:08:12.320 --> 0:08:13.960 it a little bit more. For right now, I think 0:08:14.000 --> 0:08:15.600 it's you know, we're in a pretty good position.