Sell in May and go away?
Not if you’re Morgan Stanley’s Mike Wilson, a name that will be familiar to some market participants. It was Wilson, you’re reminded, who famously predicted the Q4 2018 tech rout, garnering a reputation for being persistently bearish (as opposed to rationally bearish) in the process.
But Wilson isn’t bearish right now. In fact, he’s still bullish, even after stocks’ furious run from the March bear market lows. His rationale is simple enough. To wit, from a Monday note:
We believe this correction could be a meaningful (10%) but necessary pause that refreshes. Our bullish view has not changed, nor has the narrative – a severe recession acknowledged by all, the bottoming rate of change in economic data/earnings revisions, seemingly unlimited central bank support, unprecedented fiscal stimulus that we believe is likely to become structural in nature and that leads to rising inflation expectations sooner than the consensus expects.
The “acknowledged by all” bit is key. Stocks tend to “pull forward” the future, and if you’re not in the camp that accepts the idea that the global economy will be materially impaired forever by the pandemic, then it’s far easier to “look through” and otherwise “write off” the incoming data, which will continue to be horrific over the next several weeks.
Wilson’s constructive take rests in no small part on the notion that the market is too bearish on dividend cuts.
“In an era of sound bites and headlines, it’s easy to forget why one really owns stocks – i.e. for the future claims on excess cash flows to be distributed to shareholders”, Wilson writes, in the course of reminding anyone who may have forgotten that “the current price of a stock should reflect the discounted value of future dividends to the equity stakeholder”.
He jokes that this way of looking at things is “a bit academic and old fashioned” (as opposed to, say, thinking of stocks as your claim on the upside generated by central bank largesse), but Wilson notes that “the market does appear to be trading off dividend forecasts more than earnings”. Have a look:
While EPS forecasts continue to tail off (because it’s hard to predict earnings when companies aren’t allowed to operate), dividend futures have bounced along with the S&P.
The bottom line, Wilson says, is that “dividend risks are higher at the stock than the index level”, and with S&P dividend futures pointing to a 20% drop in dividend forecasts, Morgan reckons that’s simply “too bearish”. Based on the bank’s cash flow stress tests, it would take an epic calamity to paint corporate management teams into such a corner where they wouldn’t deploy the balance sheet to defend dividends.
Essentially, the argument is that even in an extreme stress scenario, companies will try to protect dividends given the damage to sentiment that can result from a cut. Management would rather burn through cash than risk slashing payouts, for example.
None of that is to say there’s not risk at the individual stock level, it’s just to say that, to quote Wilson again, “if investors believe dividends will only fall 15% in such a terrible economic year, it should make them feel better about the security of this stream of dividends in the future”. And, again, Morgan thinks that 15% figure could be too pessimistic.
Ultimately, Wilson emphasizes (with italics in the original) that this was a “2-year” bear market. My between-the-lines read is that he never completely abandoned his “rolling bear market” thesis from 2018, despite nods to the bullish side at various intervals. But that bear market ended in late March, he says.
While equities may be taking “their first real break” after the bounce, in Morgan’s judgement, 2650 (the 200-week moving average) will be “vigorously defended”, and the 50-week moving average (around 2992) will provide resistance.