Listen up: Morgan Stanley’s Mike Wilson isn’t done with you people yet.
Few took Mike seriously back on July 8 when, in a short Sunday evening client note, he called for “a proper rain storm” in the market’s richest “zip code”.
By “zip code”, Wilson meant Tech and Growth which he called “over-loved and over-owned.”
About three weeks later, a little rain did in fact come calling in the form a sudden lurch lower in FANG following Facebook’s Q2 fumble. After releasing a couple of additional notes reiterating his stormy forecast, Wilson showed up on CNBC in what amounted to a last ditch effort to warn you that if you thought the late July showers were something, you were ill-prepared because the “proper storm” Mike predicted on July 8 was still coming.
Fast forward to November and ol’ Mike is vindicated – and then some.
Since the highs in August, the FANG+ index has fallen for three consecutive months and is now down some 18% over the same period.
Riding high, Wilson released a note last week that documented the death of “buy the dip”, a strategy which stopped working in U.S. equities in 2018 for the first time in 16 years.
In the same note, Wilson warned of looming guidance cuts and shrinking margins, although he did suggest that most of the “valuation damage” (i.e. de-rating) has already been done.
“S&P 500 consensus 2019 EPS growth has come down by 1.2% since October 1st (before 3Q earnings season started) and this decline is in line with the 5-Yr. average of 3Q EPS growth revisions during earnings season”, Wilson wrote, before sounding a decidedly cautious tone as follows:
However, this is only the beginning in our view; we expect downward revisions to accelerate as we head into 2019 and receive full year guidance. From a sector perspective, Communication Services, Materials and Consumer Discretionary have seen the largest net declines in growth estimates over this period. Utilities and Energy have seen consensus estimates rise during earnings season. Financials estimates are basically flat since October 1st, but have turned higher over the past two weeks.
Fast forward to Monday and Wilson is out with his year-ahead U.S equities outlook which is grabbing headlines in light of his prescient call ahead of the Tech correction.
Let me just go ahead and tell you that it’s comprehensive. We’ll probably dive down deeper into this as time allows, but for the time being, note that Mike’s year-end price target for 2019 is just 2,750 on the S&P.
“Ultimately we think that continued tightening of financial conditions and decelerating growth that weighs on earnings will limit index level upside [and] we see a material slowdown in earnings growth coming next year,” Wilson writes, before acknowledging that until concrete evidence of downward revisions shows up, “the market could temporarily overshoot our base case target on valuation and price.”
Clearly, he thinks any such “overshooting” should be seen as an opportunity to sell into strength, at least until such a time as “earnings revisions to the downside are complete.”
Here’s a table summarizing Wilson’s bull, bear and base case scenarios for year-end 2019:
Last week, while explaining how “buy the dip” has failed, Wilson raised the specter of an earnings recession in 2019. That’s the foundation for his bear case which sees the S&P falling to 2,400.
“In our 2,400 bear case, the market experiences an earnings recession in 2019 as revenue slows more than expected and margin pressures become acute, with some minor offset from buybacks”, he writes.
You’re reminded (for the umpteenth time) that the market faces three major margin headwinds going forward: wage inflation, higher interest rates and tariffs.
If you’re wondering whether Wilson is sticking with his bearish Tech call, the answer is: “Of course”. And because we feel like we’d be doing him a disservice to try and paraphrase given how right Mike has been about Tech this year, we’ll excerpt directly from his Underweight Tech call for 2019. To wit:
Despite the recent price action, we retain our underweight rating on US Tech. Given its exceptional growth and quality characteristics, Tech was the last holdout in our Rolling Bear market. As rates and volatility have moved higher and the market has questioned the durability of the cycle, recent price action has shown that the market is waking up to the fact that many Tech stocks are great companies, but are riskier than previously thought. When we hear things like”Tech is no longer cyclical” or “Tech is a low vol/risk sector now,” we cannot help but think its vulnerability has reached a concerning place. Ultimately, we think relative valuations and growth expectations can still fall further in a crowded sector, acting as a drag on performance.
So there you have it, folks – straight from this year’s most accurate weatherman who was pulling out his umbrella in early July while you were still putting on sunscreen and setting up beach chairs.
Oh, one more thing: Mike’s bear case (2,400 on SPX) is the same as SocGen’s base case.