Bloomberg Audio Studios, podcasts, radio news. Joining us here at the table is Morgan Stanley, chief US equity strategist Mike Wilson. You know, people think of you as a bear also.
Mike, and also very smart.
So well, you're not really bearished this market, are you.
Well, No, we haven't been for the better part of six or eight months. We took our targets up significantly in May, sort of in the idea that you know, we were going to kind of make it through there wasn't going to be a growth scare that it caused a hard landing, and also the Fed, you know, the Fed move fifty basis points. And then of course we had the election outcome. So like we've had a lot of good things that have happened over the course of
like the last three or four months. So I would argue the markets have traded that really, really well, as they typically.
Get ahead of those things.
The question now, and I think we said on this program in October we said we think we could trade sixty one hundred on a definitive election outcome, and we got that. So now here we are sixty one hundred. Do we just revise our numbers higher? No, we're we think we're on for sixty five by n next year, assuming that things, you know, progressed the way that we expect, needing the base case of substances. We have our economic forecast for the FED.
That's where that's where they're visibility.
That's where the sort of risk is is that our forecast on the outcome is not what we expect it to be. And I think this year's next twelve months is going to be just like the last twelve months, where there's uncertainty at times around the growth outcome and any inflation outcome. But up thirty percent, well not up thirty but I mean it's but you know, the thing is the last twelve months, we got the earnings forecast exactly right, but we got underestimated was the multiple.
And I don't think I was alone in that.
I think I don't recall anyone telling me we're going to trade twenty two or twenty three times. But then when we get there, everyone just justifies it and says.
It's okay, we can stay here or even go higher.
So look, markets are a little bit diabolical. They trade ahead, and when you're trading the stock market or stocks, you need to think about what's going to be happening in six months now, what's happening today. And I think the first half of next year is where they uncertainty probably is going to increase, and then by the second half of next year things could clear. So it's going to be another I think, volatile year, plenty of training opportunity,
plenty of dispersion in the stock market. That's what we kind of focus on, what to own, not how much to own, and that's the game.
That's the game that we play.
Well, let's swap through some of that volatility, because there's the absolute level right sixty five hundred year and twenty twenty five. It feels like a lot of Wall Street has coalesced around that number. But what does the path to get there look like? What do you see the road being over the next twelve months.
So that assumes that the economy stays sort of, you know, below trend growth but healthy, so two percent real inflation continues to climb down but not you know, go in a way where its deflationary. So you have four to four four and a half percent nominal GDP growth, which gets you ten percent earnings growth. There there will be some operating leverage and then the multiple comes down a little bit, but not as much as what we would have thought this year, because look, that's just that's where
we are. It's very hard to get the multiple to come down at the Fed's cutting rates and you have above trend ernie's growth, and that's we're forecasting once again, assuming soft landing. Okay, inflation continuents and the Fed can cut. I would say the biggest risk in that outcome is on the inflation side. We're seeing inflation pick up again because look, let's be honest, we financial conditions are very
loose again, something that's the market itself. We have now animal spirits picking up because the election outcome and people are excited. That excitement has a negative consequence, which is that all of a sudden, inflation starts to pick up again and maybe the Fed can't cut.
That to me is probably the biggest risk to the multiple, that the Fed can't cut as much as people are anticipating.
In So I mean, and this may be a driver of that, But wouldn't bad certainty on tariffs, bad certainty on mass deportations, wouldn't that be bad news for the economy and for the market.
So I mean that's once again going back to our view for next year. I think the risks are front end loaded. We're going to get a lot of announcements. Like I would say, the bad stuff comes early, the good stuff from the changeover around administration comes later, meaning you know, tariffs and immigration.
You do think we'll get certainty because I feel like it's going to be a little bit like Lucy holding the football. You know, well, well Solan Trump loves to play that game. He just pulls it away every time you take a kick.
Well, I think, I.
Mean, look, policy, the way policy's made is you flow tribal loons. You see how the markets react, and then you're reflexive. I mean that's how I anticipate this to go down. And every time you get one of those sort of tribal loons and then policy actually has made you get more certainty. That doesn't mean the market's going to like it or love it. It just means we're gonna get more information as we go through. I mean, he hasn't even taken office yet, you know, so let's give it a little.
Chance there to breathe.
I would say, once again, I think that the sort of headwinds for the market are probably early policy changes, and then the good stuff, whether it's deregulation, maybe some government efficiency, maybe tax extensions or even further cuts, comes later in the year. So that's the setup for now, all subject to revision, of course, because there's a lot of other things going on as well.
Yeah, a lot of big ifs there. But I do want to talk specifically about this month. You had a really interesting note out a couple days ago talking about how usually in December you see the small caps lead. That's not what we've seen. The rustle two thousand, that's actually down about three percent over the past two weeks, and it's been big tech that's been in charge. So what is different and do you see us reverting back to some of those historical patterns.
So I think what happened is and this happens every year. We've seen we get the sort of small cap.
Trade earlier and earlier every year.
We also had the election, and we know from twenty sixteen's experience that we got we were going to get a big pop in sort of small business confidence.
We since confirmed that earlier this week.
That was the biggest increase we've seen in twenty five years small business confidence, so maybe the market kind of pre traded it. I still think the second half of this month we could see further outperformance from small caps and some cyclicals, just as you kind of mark that up into year end, and then I think you'll get a fade into January February. That's the way historically the last four or five years is trade or ten years.
Really you get the small cap trade now earlier, and then you actually fade it at the beginning of the year.
Here's two weeks of the major indexes.
If you take it out to five years, you'll see the Russell two thousand has really underperformed, and the text docks, the Nasdaq has really outperformed. Does that a pattern hold indefinitely? Is this just how it is?
Well, we've had that view for quite a while.
We just upgrade, finally upgraded small caps this summer to a neutral.
Like we're still neutral on a view.
I think right now the market is still going to be it's somewhat narrow.
I mean it's upgraded to a neutral.
We upgraded to and we have a viewer writing in who wants to know what made you change your bearest stance? What was it that made you say, Okay, you know what, I'm thrown in the towel.
We're bulled up.
Well, I mean the data, I mean basically, I mean, I mean, I think it was pretty consensus a year year and a half ago that the FEDS hiking regime was going to lead to a hard landing and it never arrived. And there are a lot of it we can go into that. We weree a long note about what was different to cycle.
Now.
To be clear, I don't think the risk of a hard landing has been extinguished, and we're still late cycle, which is why we're treading narrow again. We're treating you know, people are going for the large cap quality stocks, which is why we don't want to go full overweight on small caps or low quality.
We don't think this is the part of the cycle. Like, we're not out of the view that this.
Is going to be some big ramp in the next year, that everything's changed, right, it's still a late sight of economy. You know, rates are still pretty high, we have you know, we have cost issues with some of the smaller businesses, and most consumers are still struggling. Okay, that's not a kind of environment where small caps or low quality stocks
tend to outperform. The one last thing I'll say, though, which is I think a big missed thing that people misunderstand, is that most stocks, okay, not the big stocks, most stocks do better when inflation is actually accelerating. So if you go back and look like twenty twenty twenty one and even in twenty two, the average stock did better than the S and P five hundred when inflation was actually accelerating.
Makes sense, though you want to hold stocks to hedge inflation, right, and.
Earnings growth is better, So I do. I do think that next year. What could happen is we could have a correction in the first half of next year as perhaps inflation comes back, But that's an S and P event, and actually the average stock may not go down that much. That is an interesting kind of relative value trade that I think you know people who can do that should be thinking about right now.
Interesting. So maybe a little bit cautious when it comes to the benchmark, but still opportunities to find at the single stock level in that scenario. But I do want to get your thoughts on how the different asset classes are talking to each other, because the bond market has been so volatile, especially if you take a look at the long end, it feels like the stock market may be some enthusiasm coming out, but it doesn't necessarily just
seem to be rates driven. How do you see that relationship evolving in twenty twenty five, especially if that big risk comes to fruition and the Fed can't cut as much as expected.
So the rate correlation with equities has flip flopped quite a bit, and earlier this year it was quite negative, meaning when rates went up, it was bad for stocks, and now really since the fall, that's why we pivoted more cycnically. Stocks are now positively correlated to rates, and we think the sweet spot for ten year yelds is four to four and a half percent. Like in that range,
stocks can actually act okays as rates go higher. If we get through four and a half and if term premium starts to increase, which would be concerned about inflation, then you're going to see that correlation flip again. So we're, you know, like everybody else, we watch how markets are reacting. It's very reflexive, and but then we think once again that four to four and a half percent range is kind of a sweet spot.
All right, Mike. It is always great to speak with you, especially on a Friday.
Have a great week. Last night very very spooky. It's great to see you.
That is Mike Wilson. He is Chief US Equity Strategist.