Morgan Stanley’s Mike Wilson sees a lot of parallels with 2009.
Wilson, you might recall, is constructive on the market versus consensus. That’s somewhat frustrating for bears, given that it was Wilson who pseudo-famously predicted the meltdown in late 2018, and specifically the selloff in tech.
But the two-year, “rolling bear market” (a thesis which became a calling card of sorts for Mike) ended in late March, he said earlier this month. Now, his assessment of both equities and rates comes across as somewhat dissimilar versus the narrative from peers.
In his latest, Wilson begins by noting that “financial repression is alive and well and a big part” of the bank’s view, which he again describes as “more bullish than consensus”. He reminds you that his bullish take from March was informed by an equity risk premium that had hit levels similar to those seen in March of 2009, the GFC bottom.
When it comes to elevated multiples, Wilson notes that “the extraordinary level of rates allowed the equity market to bottom at a P/E multiple that was 30% higher than what we witnessed in 2009”.
(Morgan Stanley)
This is quite simple, really. When the Fed is hell-bent on driving investors out the risk curve and down the quality ladder, they are generally successful. As Wilson puts it, “if there is one thing we’ve learned over the past 10 years of financial repression, it’s that when risk premium appears, you need to grab it before it disappears”.
He goes on to suggest that those who insist the rally is too narrow may be wrong. To make the point, he compares the % of stocks trading above their 200-day moving average to the 2009 analog, noting the periods “look remarkably similar”.
Going a bit further on breadth, Wilson notes that “small caps have outperformed large caps since the market lows, while the Wilshire 5000 and equal weighted S&P have begun to outperform the market cap weighted S&P”.
While you’re going to have some difficulty making the case for healthy market breadth at a time when just five stocks comprise 21% of the S&P 500 (something Wilson knows all too well, given that he wrote a series of notes about market concentration earlier this year), the following simple visual is at least worth flagging.
Ultimately, Wilson sees several signs of improving breadth, which for him help make the case for the 2009 comparison.
“Not only is this comparable to what happened in 2009 but it’s also what typically happens coming out of recession”, he says, on the way to pointing out that “the ERP has almost exactly followed the same pattern, providing further support to our argument that it really isn’t different this time with financial repression so alive and well”.
(Morgan Stanley)
If there’s a fly in the ointment, it’s 10-year yields, which Wilson calls “the one major outlier compared to the 2009 experience”.
If 10-year yields remain depressed, it will call into question the notion that the recovery is on track. Morgan Stanley doubts whether the Fed can cap 10-year yields, especially if there’s a V-shaped bounce in the economy. Clearly, a bear steepening episode would have dramatic ramifications for leadership in equities.
Whether 10-year yields remain an “outlier” versus the 2009 analog is thus “a very important question to answer for equity investors”, Wilson writes. Here’s why:
- persistently lower back end rates suggest our V-shaped recovery is less likely, and
- a rising 10 year yield will have significant implications for market leadership and would lead to a very painful rotation that few investors are positioned for at this point
Notably, yields are now disconnected with Morgan cyclical/defensive equity ratio, which has rallied.
(Morgan Stanley)
That is not necessarily a “definitive” sign that yields are about to jump, but Morgan thinks it “bears close watching” because, again, if long-end yields move higher, it “would have important implications for equity portfolios and US bank stocks in particular”.
Wilson is right about one thing. Right now interest rates are not telling you that a rapid rebound is near. It does not look like the market is ripe for falling out of bed either. Unlike the last crisis 2007-2010, this one is not emanating out of the financial system but is being caused by a major exogenous shock closer to a natural disaster. Much of what happens in the next 6-12 months will depend on the progression of the virus and policies towards conatainment. In the unlikely event a vaccine or cure is imminent that would be a positive shock, as we saw market reaction to positive news on that front and a Fed chairman on 60 minutes basically declare that he would supply whatever liquidity the market needed without any effective limit. It is hard for anybody including Anthony Fauci, perhaps the most respected expert in this area to predict the course of the disease. It is way over my paygrade. My conclusion is that this is a trader’s market not an investor’s market.
Ria, not trying to suck up to you, but this is a very good comment.
Re: 10-year yields … This is a tricky one. Even with positive “down the road” headlines, J-Pow doesn’t want long rates heading higher until Main Street has recovered from the recent hit.
So the bond market’s impulse to sell off NOW will likely be met by J-Pow and his digital printing press.
I guess it’s a timing issue, and we know you can’t ignore the Fed’s desire to buy everything in order to engineer a full recovery.
So maybe Bank Stocks can rally a bit now (…after being smashed and then lagging in this bounce), but may have to wait for their own Full Recovery (?)
So the 10yr yields are a little low – look at the deflation outside the US and the fact that the whole world is hanging off the Fed’s rates. Wilson has it right and the 10’s will creep – and jump a bit – higher from here. Leadership will shift – it always does. Anyway – it is MAGA+F – in my mind and the whole MAGA bit is becoming a cruel joke. As long as we believe in ERP – and why not – we are heading up, Mike’s chart shows a low in August, so there is still underbrush ahead. The next dip in equities we will all be buyers, thanking God for the chance.