Mike Wilson was “surprised” by the “magnitude” of a bear market rally that propelled US equities to four consecutive weekly gains and found tech shares trading more than 20% from the lows.
But surprised isn’t synonymous with impressed, let alone convinced. Long story short, Wilson isn’t buying it. Not figuratively and not literally either.
In his latest, out Monday, Wilson attributed the rally in part to better-than-expected earnings and a well-documented positioning squeeze, but suggested the underlying, psychological motivation was investors’ faith in the reinstatement of the vaunted “Fed put.” To the extent markets expect a pivot, Wilson believes such hopes might be misplaced.
He drew a parallel with 2019, when Jerome Powell’s infamous January pivot eventually morphed into rate cuts as Donald Trump dialed up tensions with China in an effort to extract trade concessions from a recalcitrant Beijing. Then, as now, “late-cycle earnings growth headwinds were apparent” and Morgan Stanley’s leading earnings model “pointed to negative growth 12 months out,” Wilson said. “Yet equities brushed off fundamental risks, and the market multiple expanded some five turns.”
If it happened then, why not now? Well, for one thing, a Fed pause isn’t especially likely. Or at least not in the very near-term. And probably not in the medium-term either, depending on how you define “medium” and also the extent to which you’re inclined to take officials at their word when they say they’re committed to seeing inflation move substantially and durably lower before taking a break. As Wilson put it, “the equity market has already discounted a durable Fed pause, the likelihood of which is low to begin with.”
But aside from that, he argued that the macro backdrop and fundamental outlook are significantly worse today than they were in 2019. You can pretty much just pick a data point (any data point) if it’s proof you seek. Most obviously, the US is in a technical recession, but Wilson simply pointed to the consumer mood and small business sentiment, both of which are severely depressed (figure on the left, below).
He also flagged one of his favorite leading indicators: ISM versus the new orders/inventories spread, which suggests the headline gauge has further to fall (figure on the right, above).
Outside of the labor market (a lagging indicator which may be even further behind this cycle due to the acute shortage of workers), things aren’t going well. On Monday alone, the NAHB declared the US housing market in a recession and the Empire Fed gauge printed a wild miss.
Wilson spoke at some length about the “Fed pause” narrative, which he pretty clearly believes is a canard. Fed officials would agree. Neel Kashkari and Mary Daly have been especially adamant about dispelling the idea that Fed cuts are likely in 2023, consistent with market pricing. That Kashkari has discovered his inner hawk may suggest the Committee is trying to send a very clear message to markets which, so far anyway, aren’t listening.
That latter point is important. As Wilson wrote, “easing financial conditions… likely further dampen the prospects for a more dovish policy path.” As discussed here at some length since the July FOMC meeting, markets’ misinterpretation of Powell’s press conference and then, last week, the ebullient reaction in risk assets to a cooler-than-expected read on consumer prices, resulted in a counterproductive easing impulse (figure below) driven mostly by stocks.
Rates understand the Fed calculus better than equities, something I detailed here last week. “Despite a ‘policy relief’ trade playing out across asset classes following the CPI report, we do not believe the categories contributing to the downside surprise justify a relaxation of either Fed pricing (barring a lowering of the probability of a 75bps hike in September) or lower levels of rates at longer maturities,” Goldman’s Praveen Korapaty remarked, adding that “the repricing in the rates market has been more measured compared to other asset classes.”
For Morgan’s Wilson, the bottom line is simple enough. “Equity multiples [are] significantly disconnected from fundamentals, which continue to suggest we’re in a late cycle, slowing growth environment,” he wrote Monday, noting that the bank’s fair value framework suggests the market is trading as much as four turns too rich.
“The message from us for the next several months remains: Risk/reward is unattractive, and this bear market remains incomplete,” Wilson said.
Sorry, what do you mean “four turns too rich”?.
multiple turns.
That’s just ridiculous number! Wilson has got this market so wrong. Q2 turned out to be fine, but the Q3 guidance was actually much better than expected. Ofcourse, we are now all looking to see what Q4 guidance might bring and this could be the crunch quarter. As Mr H knows, this rally has been mainly driven by the systematic strategies increasing their net exposures and there could be more to go before we see another downward correction.
I basically agree, but I think the economy is cooling off faster and harder than most, which is why I think there will be cuts next year. That said when it happens stocks won’t be celebrating.
Seems clear stocks are ignoring the Fed’s message recently, I keep thinking about the confluence of reasons that might explain why the market appears so convinced a Fed pivot will happen relatively soon. The hawkish statements emanating from Fed members would have been more than enough to kill any rally just 2 months ago. Systematic strategies and algos probably weight both leading economic data and Fed pronouncements into their input variables, so my guess is the machines see a growth slowdown certain and significant enough to override any sell signal triggered by Fed headlines. In any case, I think we won’t have to weight long to see if Wilson has this right.