Why Bulls ‘Have A Lot Of Explaining To Do’

Late last week, I noted that although stocks may be the best inflation hedge on the board, US equities are nevertheless on track for their worst annual performance in almost 50 years when measured in real terms.

As Warren Buffett put it over the weekend, during Berkshire’s first in-person congregation since COVID, inflation “swindles almost everybody.”

It’s possible, Morgan Stanley’s Mike Wilson suggested Monday, that investors have been swindled (to employ Buffett’s antique cadence) into believing the S&P is still in a bull market.

“The S&P 500 has come full circle on the year, starting in May 2021 at 4200 and now nearly a year later, we’re at 4135,” Wilson said, before noting that once you adjust for March’s scorching-hot headline CPI print, trailing 12-month real returns were -10% and -8% including dividends.” Obviously, those figures are far worse for the Nasdaq 100 and the Russell 2000.

That rather stark reality means bulls have “a lot of explaining to do,” Wilson mused, in the course of highlighting a related factoid: The real earnings yield on the S&P is now the most negative in 70 years (figure below) which, he helpfully explained, “theoretically means you’re buying -4% earnings contraction at today’s levels.”

It doesn’t help that companies like Amazon are now guiding for a slowdown in top line growth. If corporate revenues decelerate, that would cast considerable doubt on the inflation protection afforded by equities.

If you’re wondering whether there’s a relationship between trends in the real earnings yield and inflation-adjusted equity prices, the answer is “sort of.” But it’s not strong enough for me to feel comfortable presenting it as “evidence.”

Wilson acknowledged that the relationship “isn’t perfect,” but pointed to 2001 and 2008 as instances when it’s been reasonably reliable as a leading indicator. The bottom line, he said, is that even if the real earnings yield has bottomed (i.e., if inflation has peaked), Morgan believes the market will “continue to move lower from here.”

The slowdown the bank’s US equity team has spent months predicting “is now front and center,” Wilson declared. “Stocks have been warning of this for months and now the evidence is becoming more obvious to all.”

Something tells me the bulls don’t see it that way and even if they do, they won’t say so until it’s too late.

Read more: Mike Wilson’s Slowdown Call Plays Out To Perfection

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One thought on “Why Bulls ‘Have A Lot Of Explaining To Do’

  1. “Everyone” is talking up a post-Fed relief rally. I’d have thought that the wise guys would be front running the trade today & tomorrow. It’ll be no surprise if the JP Morgan team calls for a rally from here.

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