“It’s too early to get bullish,” Morgan Stanley’s Mike Wilson said Monday.
At this point, I doubt many market participants would disagree. Indeed, Wilson noted that his bearish view is “no longer out of consensus.” Bear markets have a way of bringing the bulls around in a way that bull markets never seem to sway the most ardent bears, no matter how long they persist.
But just because the bear trade suddenly seems crowded, it’s not necessarily time to fade pervasive gloom. Wilson called bearishness “a necessary condition for a sustainable low, but an insufficient one.”
Late last week, I noted that client allocations to equities at BofA are still near record highs, while cash allocations are just barely back to the long-term average, and nowhere near panic levels seen during February of 2009. Morgan’s Wilson said “asset owner clients remain heavily exposed to equities” and cautioned that any reallocation could “further weigh on prices.”
One of the pressing questions is whether the de-rating behind 2022’s bear market has run its course.
Despite a ~25% decline in the index multiple from the peak (figure above), some see scope for more.
At the least, there’s skepticism around the notion that it makes sense to apply lofty multiples at a time when rates are sharply higher and central banks are committed to aggressive policy tightening. Last week, for example, one popular strategist said a “20th century” multiple of 14x is more appropriate for a stagflationary macro environment.
“There are virtually no clients arguing for 20x+ P/Es any longer,” Wilson remarked on Monday. The sensitivity analysis (below) appeared to suggest stocks were actually a semblance of fairly valued last week. But there are caveats.
Wilson said Morgan’s US equities team would agree that the de-rating is mostly complete were it not for the prospect of significant earnings downside.
Over the weekend, I not-so-gently suggested US corporate profit forecasts need a reset. If you look at the 12-month window capturing the six months leading into a recession and the six months following the onset of a downturn, analysts cut estimates by a median of 22%, according to Goldman.
Irrespective of whether you’re buying the recession story, management commentary accompanying recent earnings reports from America’s largest retailers points to a weakened consumer. And the US economy lives and dies by consumption (much like me, during the Balvenie years).
“P/Es typically lead EPS revisions and this time should be no different,” Wilson wrote Monday. “Bottom line, we believe the S&P 500 P/E will fall toward 14x ahead of the oncoming downward EPS revisions,” he added, calling S&P 3400 “a level that more accurately reflects the earnings risk ahead.”
Morgan Stanley thinks the index will fall to that level by the end of Q2 reporting season. “Until then, vicious bear market rallies should be used to lighten up on the areas most vulnerable to the oncoming earnings reset,” Wilson said.
If Cisco is any indication, the shutdown in China could have a greater negative impact than current earnings forecasts assume.
The picture is probably more complicated. We are in a reset for growth and tech oriented names. They are being derated and earnings under pressure. Same with retailers selling hard goods. Other sectors may be faring better- energy is a prime example of this. Perhaps services are another example, although many are not publicly traded. Too bad, energyprivate services is a low percentage of most broad averages. Plunging earnings are a precursor to layoffs and retrenchment. It looks to me like the market is more of a mixed bag and for 2022 at least the micro picture may be as important as a top down macro analysis. But that may only be a 2022 story. Next year could be a completely different deal- if /when the Fed cracks the economy. If we do see a crack, maybe financials are a good play for an early rebound. Anyway have bloviated too much already. Thanks.
You make good points, Ria. Please do not hesitate to bloviate whenever you feel the impulse. We are all just trying to imagine how these large, slow-moving financial questions play out, and implications for our own positions. You add good color to the scene painted by H.
+1. More RIA, never a problem.