One bank’s “hotter but shorter” cycle thesis is beginning to look quite prescient.
Around a year ago, Morgan Stanley suggested the rapid acceleration in growth and profits following the pandemic downturn would pave the way for inflation and, ultimately, force the Fed to abandon even the pretense of a gradualist approach to stimulus unwind in favor a dramatic, hawkish about-face.
Leaving aside the labor market, where participation likely won’t return to the pre-pandemic demographic trend thanks to early retirements and other factors, the economy and markets left the pandemic in the rearview long ago. Stocks, bond yields, consumption, aggregate output and so on, topped pre-COVID levels and kept going (simple figure below).
Inflation is scorching and some Fed officials are publicly calling for the equivalent of a dozen rate hikes in 10 months.
In a Sunday note, Morgan’s Mike Wilson revisited the “hotter but shorter” thesis. “Just 22 months after the end of the last recession, our cross-asset team’s US cycle model is already approaching prior peaks,” he wrote, noting that at the current pace, the indicator could peak as early as June, before moving into a downturn phase between five and 10 months from now.
Consider the figure (below). This time really is different.
Profits, revenue, margins, multiples and, ultimately, stock prices, recovered at a record (or near-record) pace. Earnings, Wilson marveled, rebounded to prior-cycle peaks in a mere 16 months.
So, what’s next? Well, the hangover, naturally.
“The early-to-mid-cycle benefits of positive operating leverage have come and gone, and US corporates now face decelerating sales growth coupled with higher costs,” Wilson cautioned, adding that the bank’s leading earnings model “point[s] to a deceleration in EPS growth toward zero over the coming months.”
He (re)drew a parallel with the 1940s, noting that “excess household savings unleashed on an economy constrained by supply set the stage for breakout inflation both then and now.” If that analogue holds, a slowdown is imminent, even if an actual recession isn’t. Wilson also reiterated the notion that the US economy may be sitting on an inventory glut it doesn’t know it has.
As for the curve, inversions don’t “guarantee” a recession and, as Wilson pointed out, Morgan’s economists actually don’t see one. That said, the bank does expect a “sharp” deceleration in earnings growth, which Wilson called “one more piece of evidence that says it’s late-cycle.”
Umm, yup. This also dovetails with the commodities crash thesis. Also, the Chinese real estate/construction industry collapse and contagion. The final straw will be a global decline in real estate values. Then all the financial dominos.
I believe the FED and Congress will, post real estate crash, start to implement policy/legislation to stop housing from becoming a bubble again. Similar to what Zoltan has been saying, but I think it will happen without a direct “assault” to cause the crash, but after the crash, the mantra being never again.
Oh, there should however be a good, strong 6-12 months up in US equities prior to the crash, the final melt up. Foreign inflows, crowding into the mega caps and defensives. I’m watching Apple as my key indicator. When it bottoms, the market bottoms. When it peaks the market peaks.
Oh, one more thought, those not familiar with the 18 year real estate cycle theory, I recommend looking it up. Essentially, the growth in real estate values peaks on average ever 14 years. 2008 was 14 years ago.
Mr Hopium,
Although the end is near, I have a vision that expands the timeline of our pending demise. I think we’re currently at the beginning of an entirely new area of securitization, which will encompass explosive growth in hybrid mortgage products, primarily targeting millennials, who find themselves at a disadvantage competing for homes.
The pandemic housing market dovetailed with a demographic trend that was firmly in place before chaos exploded. Going forward there will be some markets pull back but home prices will be continue climbing, regardless of meaningless micro Fed adjustments. There’s too much cash waiting for too few houses and between investors and wealthy baby boomers. There’s also an increased amount of millennials with decent funding.
That powerful cohort combination is pricing out a huge group of people that can’t compete in what will amount to an cash housing market, thus, we’re starting to see interest in cooperative partnerships evolve, like a few friends signing a mortgage and using combined leverage to secure housing. It’s a step beyond a husband and wife combined incomes and debts, more complicated, yet a way to get into the game.
That’s the vehicle for the top of the market in terms of utter stupidity, but that peak insanity may be there years out. The extension of crazy will help fuel new instability with far greater risk and a concentration of wealth into an increasingly illiquid asset.
As the casino grows hotter more moths will be attracted to the enchantingly beautiful bright lite which on closer inspection will be the flames of ruin.
“the bank’s leading earnings model “point[s] to a deceleration in EPS growth toward zero over the coming months.” ”
SP500 EPS estimates need to roll over pretty hard and fast then, because right now analysts are still looking for +9% EPS growth in 2022, +10% in 2023, +11% in 2024 . . . and each year’s estimate is still marching up e.g. 2022 was $222.97 in Jan, $223.50 in Feb, $225.13 in Mar.
If we do go from those rosy estimates to zero-ish growth, who wants to bet on SP500 holding its current 19.4X NTM PE, a multiple higher than any time from 2002 to Feb 2020?