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