Morgan Stanley Chief US Equity Strategist Mike Wilson Talks Fed Rate Cuts

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Mike, Good morning, sir, Morning John.

I want to pick up on I think a coal view of yours for twenty twenty five coming into twenty twenty six, recessions behind us. I think that's somewhat unique to you and a team at Morgan Stanley just built that out for us.

Yeah, I mean, you know, we try to work six months in the future. I think in a year ago. I think remember we had this conversation after the election. You were saying, make you sound more optimistic than I've heard you in a while, and it was kind of we were.

Thinking six months in advance.

We thought the first half would be tough as they transitioned from the kind of growth negative policies.

To these growth positive policies.

All this capex you're talking about is right in line with the big beautiful bill. I mean, they're trying to basically reduce consumption increase investment. Okay, it's a totally different economy. And what that is, it's a higher velocity economy. For all the companies that haven't been doing well for the last I would say three years, we've been sort of in a recession.

I would argue strong.

We've done the work on this, and you know, we've done analysis with respect to the rolling recession that has been in place or I would say three years, most of the privatey, economy kind of suffering, government kind of carrying the water, and then we basically saw all of that come to fruition at the end in April. April capitulation day as I call it, was basically the government recession that was the final piece of the rolling recession.

So rolling recovery, where are we that strges?

So we deemed at the rolling recovery in April, and we're now seeing that, like these areas of the marketer, not everything's going to recover it once, because it's a it's an unorthodox recession. It's not like everything flushed at once and everything recovers at once, So it is going to be staged, and we've seen it in the market. We're still narrow quite frankly, AI campbex Is still is kind of one of early recoveries here, semiconductors being an

Much lower? How much lower do you think that really is required to get that broadening out?

Well, let's just start with the two year treasury yield.

Okay, So my barometer is always the FED is behind the curve. If FED funds is above two year treasury yields, and in order to stimulate the private economy, I would say they need to be well below that.

So that's fifty.

Basis points just to get the neutral and maybe another one hundred plus to get to something that's more stimulative for the average company and the average consumer.

Are you right now betting on that broadening out and expecting maybe AI to underperform going forward as they invest more in some of these debt sales and the infrastructure side and the rest of the economy plays catch up.

Absolutely, think about the trickle down effect of this capital spending. I mean, it's not just going to be semi conunter companies. There's a lot of infrastructure, there's a lot of job creation, there's a lot of velocity in a real economy, and the lending channels starts getting going, perhaps for small medium businesses that job creation. Deregulation is another part of that story.

Okay, so absolutely that's.

What should happen if things play out the way they could.

Now there's risk to that.

Let's say that FED continues to say, hey, we still think there's inflation risk, we don't like the inflationary three percent, we're not going to raise our targets there, and then we just kind of drag their feet.

It's going to stay narrow.

Then it's going to stay up the quality curve, and that's where we are right now. He says that people basically are trying to choose between those two outcomes, and I would say right now, most institutional community is still huddled into the high quality stocks. They haven't really made the transition yet. Well, we have in some of our guidance.

Yeah.

Absolutely, In order for that transition to work, the FED has to cut though.

That's what it's contingent on.

It's one of the main things now. Drag is a big part of that. Okay, the capital spending is a part of that. Those can happen without the FED cutting significantly, but it would really, it would really solidify it for me. And if you go back and look at all these different economic cycles, small caps and lower quality stocks typically don't outperform until the FED gets below two year treasury heels. We've we've documented this, so by the way, it doesn't

If you look at the FED next year, are you just expecting a federal reserve that's markedly different than it was today than it is today?

Well, I think they're just I think they're being patient here, They're doing their job. I'm not wanting to sit here and criticize the Fed left and right.

What I see is just a very.

Weird economic cycle, and I think we've kind of we've solved the puzzle a little bit on this, and that's why I feel fairly confident that our narrative we laid out this year is played out.

Now.

I'm getting evidence in the marketplace, and I feel more confident in that narrative. And that's sort of the difference. I just think they're not there yet, you know, they're not where I am in my head. I could be wrong, but I'm pretty confident about that outcome.

Can we finish on big tench?

Sure?

These companies are changing. We're used to companies that weren't investing tons ultimately, that were giving it back to shareholders. Now we've seen a subtle twist I think from the likes of say Meta, who was spending tons and tons and tons and then coming to the debt market to fund it. That's not what we're used to with these names typically the asset like capital return heavy. Are you not seeing the same change? And how should we treat those companies differently of at all? Because of that?

So let's talk about the risks for the bullmarket.

We think a bull market started in April new economic earning cycle.

Okay, there are two risks.

One is it the FED drags their feed liquidity funding market stresses kind of pop up. The second one is what you just talked about, is that the market starts to push back on the fact that free cash flow growth is actually decelerating for some of these businesses and the asset light story is being called into question.

We haven't seen it yeto the last week.

Was the first sign we saw pretty diversion performance between some of these and that's a risk because if all of a sudden the market starts to become a governing factor on those stocks. I can guarantee you that the management teams are going to say, well, maybe we aren't going to spend quite as much, just like we saw in the fall of twenty twenty four as we talked about the deceleration and campex, and also we saw that with other times when these companies spend much money the market

Is it welcome news that they're leaning on the debt market a little bit more, just as a sequity market starts to push back.

Well, I think that. I mean, I think it's a natural evolution.

And and and just to be clear, in all these buildouts, whether it's railroads, electricity, uh, the internet itself, Okay, we got to get renown to the debt part. Okay, So now they just raised a ton of capital, Well, they're not going to sit They're going to spend it. So like that's another reason to be excited on one hand, because we know that money is going to get spent,

Over when they just raised gobs and gobs of dollars.

Do you think it japanizes comportive term programs as these companies take on more leverage.

Yeah, it's competing for the for the free cash flow. So whether it's camp and by the way, Capex now is a percentage of free cash flow is pretty high for these businesses. But once again, I want to go back, this is this is by design.

Okay.

The tax bill is basically incenting these companies to do it. Now, I mean, the government administration is really encouraging businesses of all types to start investing for the first time in fifteen years. We've underinvested in so many things, not just you know, AI, but like infrastructure and factories and you know, automating production and robotics and things like that. I mean, this bill is designed to get that engine of growth moving.

And it's happening. It's just putting all these pieces together. This was a core theme, I think, a core pillar for being long US equities for a long long time. And now it's changed. Is it still good? I think that's what I'm trying to get out here. Is this still an argument to buying US ecrities.

I think that the valuation, you know, is telling you that the growth is going to be better than we think. My view is that earning SC is going to be better next year than people expect.

Now.

On the other side of that, I do think we're in a different environment where we have these hotter but shorter cycles. Okay, so we're not in these ten year economic expansions anymore, and so it's two years on, one year off, two years on, one year off. That's what we've had since COVID right twenty twenty twenty twenty one good, twenty two bad, twenty three, twenty four good, twenty four to twenty.

Five, and that's so good. Now we're into a new two year cycle.

So you just have to understand that because inflation is right under the surface, and now you have a higher velocity economy that means you're going to have to trade it a little bit more. For right now, I think it's you know, we're in a pretty good position.