Episode Details

As investors attempt to find opportunities in an uncertain stock market, earnings disappointments and an ongoing debt ceiling debate loom overhead.

----- Transcript -----

Welcome to Thoughts on the Market. I'm Mike Wilson, Chief Investment Officer and Chief U.S. Equity Strategist for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about the latest trends in the financial marketplace. It's Tuesday, May 16th, at 1 p.m. in New York. So let's get after it. 

Having spent the last few weeks on the road engaging with clients from around the world, I figured it would be useful to share some thoughts from our meetings and to touch on the most often asked questions, concerns and pushback to our views. 

First, conviction levels are low, given broadly elevated valuations and a challenging macro backdrop. While many individual longs and shorts have worked well in the context of a buoyant S&P 500, the most favorite trades have largely played out and clients are having trouble finding the next opportunity. Small cap and low quality stocks have underperformed and we continue to see crowding into mega-cap tech and consumer staples stocks as safe havens in a deteriorating growth environment.

Second, there isn't much interest in the S&P 500 as either a long or a short anymore. Most clients we speak with have given up on the idea of a big breakdown of the index level. Conversely, there are few who think the S&P 500 can trade much above 4200, which has proven to be a key resistance since the October lows. What has changed is that the floor has been raised, with the large majority of investors thinking 3800 is now unlikely to be broken to the downside. In short, the consensus believes the bear market ended in October, at least for the high quality S&P 500 and NASDAQ. 

Third, there is little appetite to dive back into the areas of the market that have significantly underperformed like regional banks, small caps and energy. Other deep cyclicals are also out of favor due to either extended valuation and high earnings expectations In the case of industrials, and recession risk in the case of materials. Instead, most clients we spoke with remained comfortably long, large cap tech stocks, especially given the group's recent outperformance. While consumer staples and other defensives have outperformed strongly since March, there's less confidence this outperformance can continue. 

Our take remains the same. The market is speaking loudly under the surface, with its classic late cycle leadership and extreme narrowness, it is bracing for further macro and earnings disappointments. However, it is not yet pricing these outcomes at the index level. Such is the typical pattern exhibited by equity markets until clearer evidence of an economic recession arrives, or the risks of one are fully extinguished. With our economist forecasting close to 0% growth this year for real GDP and just modest growth next year, valuations at full levels and several other risks in front of us, we suspect 4200 will hold to the upside as most clients suggest. However, we continue to hold a more bearish tactical view than most clients in terms of the downside risk given our earnings forecast. The majority of our fundamental debate with clients has been over earnings. More specifically, there is broad pushback to our view that margins have not yet bottomed. In addition, many clients do not think revenue growth can fall towards zero or go negative given the still elevated inflation across the economy. Our take is that while many companies have taken decisive cost action, including layoffs, they have not yet cut cost nearly enough for a zero-to-negative revenue growth backdrop. But the odds of such an outcome increasing, in our view, we find it notable that many investors are more sanguine today on the earnings backdrop than they w