Wordz And Multiplez

Sometimes I wonder if readers ever marvel at the sheer number of different avenues I go down in order to say essentially the same things and arrive at the same conclusions.

I often chuckle at how generous journalists are to themselves in that regard. I’m not a journalist. I’m just a guy who got lucky and now spends his copious spare time documenting socioeconomic trends, other people’s adventures in capital markets and, occasionally, life in general.

But I’ve known some journalists. And some editors. I cut all of them off in January for no good reason. I needed to brush up on my bridge-burning skills, which I feared may have fallen into disrepair after all these years of sobriety. If I were a journalist or an editor, I’d probably flatter myself and say I have a unique talent for “approaching stories from multiple angles.” Or some other self-congratulatory nonsense. One journalist-turned editor for a major financial news outlet once told me I “certainly have a voice.” Apparently not one she cared to hear, though. Maybe it wasn’t me. Maybe she just didn’t like phones. (For the Steve Martin fans: “She hates these cans! Stay away from the cans!”)

Really, I have a knack for telling the same set of stories with new words. What separates me from… well, from nearly everyone, is that I know more words and I’m better at putting them together. As one former president put it, “I’m very highly educated. I know words. I know the best words. But there’s no better word than ‘stupid.'”

If you wanted the “stupid” version of a theme I’ve riffed on ceaselessly of late, it might go something like this: Equities may keep going higher if people keeping buying them.

Morgan Stanley’s Mike Wilson agrees. “Until money stops flowing into equities from retail and other asset owners deciding there is no other alternative, the index level multiple and price may remain elevated,” he wrote, in a collection of words dated Monday.

As a reminder, the YTD inflow into global equities is now $613 billion. That’s a large number. It seems even larger if you extrapolate from it and compare it to smaller numbers (figure below).

If you were wondering, the YTD inflow to US equity funds (specifically) is $217 billion.

In the same note mentioned above, Morgan’s Wilson said he’s “surprised how much investors have been willing to pay” for what he characterized as “over-earnings” attributable to “government subsidies” which the bank credited with “provid[ing] a huge windfall in operating leverage and profits.”

The market (being an efficient, discerning, price discovery mechanism and all that) should have de-rated by now at the index level. But, as noted, people keep buying stocks for a variety of reasons including, but not limited to, their relative attractiveness to bonds. Overvalued stocks look great compared to assets that are even more overvalued. (Just like I’m Henry James compared to journalists and market commentators who can’t write.) So, the index-level multiple hasn’t really compressed. (And people tell me I missed my calling as the reincarnation of Ernest Hemingway.)

But that doesn’t mean the index won’t de-rate, Wilson said. “In fact, the P/E compression is happening for the average stock as the market gets more and more narrow,” he wrote, flagging what he called a “major divergence” between the P/E of the average stock and the cap-weighted index (figure from Morgan, below).

He went on to say that under the proverbial hood, drawdowns are observable, especially within cyclicals and other expressions tied to the reflation theme, which fell out of favor recently amid Delta variant concerns and a growth scare optic in the curve exacerbated by an overwrought Fed “policy mistake” narrative. Almost half of S&P 500 members “have experienced a drawdown greater than 10% since May 1, while the index hasn’t corrected more than 4%,” Wilson remarked.

As discussed here in “Can’t Lose,” index-level performance is increasingly tied to a handful of stocks, many of which report this week. For Wilson, it’s just a matter of time. “In our experience, these higher quality, mega-cap leaders particularly within Tech are often the last holdouts in a rolling correction,” he said Monday, adding that although they’ve “proved durable thus far,” the bank’s view is that “a combination of demand payback post-COVID and a changing liquidity picture for the worse will weigh on performance of this cohort as well.”

Perhaps most ominous is the figure below, again from Morgan.

The bank calculated the percentage of sell-side ratings that are Overweight or Buys for the top 1,000 stocks by market cap. “At present, the percentage of OW ratings is 59%, the highest since the passage of SOX and a clear outlier over the last 18 years,” Wilson wrote, adding that “prior peak ratings have occurred as markets moved higher and then corrected with analysts calling to ‘buy the dip’.”

Of course, in the post-GFC era, there have been no truer words than “buy the dip.”