“You are here”, reads a conspicuous red annotation on a chart showing earnings forecasts bottoming in 2009.
The visual is from Morgan Stanley’s Mike Wilson who, much to the chagrin of a bearish echo chamber which attempted to adopt him as one of their own in 2018, has been persistently (and correctly) bullish since March.
Wilson apparently understands that bearish prognostications have to be based on sound reasoning, or at least on what one believes to be sound reasoning at the time — never bearishness simply for the sake of bearishness.
He correctly called the Q4 2018 selloff (and specifically the rout in tech that year) based on a solid thesis, not on some grudge he held against the market. But, he’s been steadfastly constructive from the lows in March, consistent with Morgan’s house view on the recovery, which the bank sees as “V-shaped”.
“As noted in our mid-year outlook, markets trade at peak multiples when earnings forecasts are at the trough of the cycle, like now”, he writes, in a new note. It’s a response to client questions and press reports detailing how purportedly expensive and “way ahead of fundamentals” stocks are.
For Wilson, the dramatic recovery in equities is anticipating a “V-shaped” recovery in the economy, and also a similarly dramatic inflection in earnings.
Profit forecasts “troughed in mid May [and] while some might contend earnings forecasts remain too high, we would argue otherwise”, he goes on to say, before venturing that “in fact, based on our analysis of earnings revision breadth, we are highly confident that NTM EPS forecasts have bottomed”.
Not only that, the bank is looking for what Wilson describes as a “very steep” increase looking out into the back half of the year, which he notes is “typical coming out of a recession”.
Of course, many of you will argue that we’re not, in fact, “coming out of a recession” — that we’re still in one, and are likely to remain so for some time. News that Arizona is joining Texas and Florida in reimposing some lockdown measures in response to surging coronavirus cases argues the point.
And yet, harping on the likelihood of flare-ups and even a true “second wave” has put you on the wrong side of the trade for three months. That’s a forgivable transgression considering the economic backdrop, but not in the context of Fed liquidity and fiscal stimulus. That is, you could certainly forgive someone for being bearish (or at least gun-shy) in the face of the worst data in the history of modern economic statistics, but less forgivable is the “sin” of doubting the Fed’s omnipotence. They do, after all, conjure money.
In any case, Wilson goes on to reiterate that this time looks quite a bit like 2009 in many ways.
“The seemingly excessive valuations at the moment are simply pricing in the fact that NTM EPS have bottomed and are likely to rebound sharply from here as the economy recovers and operating leverage returns, as it always does after a recession”, he says, before suggesting that in the bank’s view, “this operating leverage could be even greater than normal given the severity of the unemployment cycle this time and the government’s willingness to supplement those individuals who are out of work to a greater degree than usual”.
If you’re wondering whether this “sticking to our guns” take means Wilson still prefers cyclicals, the answer is yes.
The bottom line (in case it’s somehow not clear enough from Mike’s amusingly straightforward missive), is that Morgan sees plenty of parallels between the recovery in equities and past downturns.
“Price action, leadership, and forward earnings estimates all point toward a robust V-shaped recovery in the economy”, Wilson insists.
He does, however, concede that this is at least “challenged” by rising COVID cases in some locales and a possible Democratic sweep in November, which would have the potential to impact profits through a rolling back of the corporate tax cuts.