Mike Wilson Worries Bears Aren’t Bearish Enough

Morgan Stanley’s Mike Wilson can scarcely remember a time when he’s had as much interaction with clients during the first week of a year as he did in 2023.

“Normally, investors start the year with a set view and portfolio and have even less use than normal for equity strategists,” he wrote Monday, employing the delightfully deadpan cadence that often pervades his notes and television cameos.

This year, he said, market participants are “less confident” in the outlook coming out of a vexing 2022 and reeling from three months of price action which, at times, seemed disconnected entirely from any sort of fundamentals.

Lacking conviction, clients reached out to Wilson, who’s basking in the limelight after successfully navigating the most difficult year for multi-asset investors in a generation. Wilson’s calls in 2022 were, at times, almost comically prescient. Not since late 2018 has he enjoyed this much celebrity.

According to Wilson, clients’ overarching concern is that the consensus view may be wrong. That view centers around the notion that the first half of 2023 could be rough, but the second half less so. “Wrapped into this view is the notion that a majority of clients and many strategists believe we will experience a mild recession starting in the first half,” Wilson wrote. “The Fed will cut rates in response, and the recovery will ensue.”

He conceded that, in fact, Morgan Stanley shares that view, but cautioned that the crowd may be “wrong on the magnitude and rationale” which, in turn, could “inhibit their ability to monetize swings.”

Wilson described investors’ attitude towards a mild recession and accompanying stock swoon as “nonchalant.” Clients, he suggested, think the S&P would likely find a durable low between 3,500 and 3,600, which he contrasted with the more bearish mood that prevailed just prior the bear market rally in October and November (which, by the way, Wilson nailed almost to the day).

He attributed the relatively sanguine view to the notion that investors believe a Fed pause is close and the possibility that with a slowdown now well socialized, the shock value of a recession would be commensurately diminished. “We would caution against those conclusions,” he warned, noting that there were “similar” arguments bandied about in August 2001 and 2008. He also noted that although the multiple compression leg of the bear market might’ve been last year’s news, valuations still aren’t cheap “and a Fed pause will likely not lead to higher P/Es if growth is really rolling over.”

For Wilson, the ERP is still “way too low” in the context of a challenging environment for earnings. “When a recession arrives, the ERP always rises significantly from whatever level you are starting at,” he reminded investors. “In other words, if you think a mild recession is coming, you cannot assume the market has priced it given the ERP is at its lowest level since the run up to the GFC.”

I should note that Wilson doesn’t expect GFC-style “financial stress” and therefore assumes a much more modest rise in the ERP.

There was plenty to parse in Wilson’s latest. It’s trenchant — perhaps distressingly so if you’re a steadfast bull. I’ll likely circle back to touch on some of the specifics given the proximity of earnings season and Wilson’s well-known views on the outlook for US corporate profits.

But his overarching point on Monday was that the S&P could trade down to 3,000 in the event of a recession. “If the ERP rises by 250bps in a recession, and the 10-yield US Treasury yield subsequently declines to 2.75%, the P/E would fall to 13.2x, 22% below current levels,” he wrote, adding that earnings forecasts would probably fall too, introducing additional downside.

“The bottom line: We don’t think a 3,500-3,600 S&P 500 is consistent with the consensus view for a mild recession,” he said. “That is one way the consensus could be right directionally, but wrong in terms of magnitude.”


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10 thoughts on “Mike Wilson Worries Bears Aren’t Bearish Enough

  1. Here are my thoughts on my personal positioning for 2023:
    Dividends and income from rental properties cover most, but not all of my living expenses (no rehabs or expensive indulgences planned for 2023). I will attempt to time a liquidation of some shares (probably a small, under the radar tech holding that has done extremely well compared to tech, in general- ie down only 5.5% vs. 30% for QQQ where I have a lot of “key man” risk that I want to minimize) to make sure I’m good through 2023. Will hold everything else, but might move some more individual holdings into SPY. I did, however, move my 89 year old parents from CD’s to USTs (2-3 yr maturities) this past December and into last week.
    Let the rollercoaster roll.

  2. ” reeling from three months of price action which, at times, seemed disconnected entirely from any sort of fundamentals.”

    No different than a casino in Las Vegas or Macao!

  3. I’m curious what discount rate Wilson is using. If I use rF 2.75% and ERP 5.00%, with the SP500’s aggregate capital structure, I get a WACC about 7%.

  4. Feels like the point here is that if S&P earnings come in close to 200, the ERP expansion will drive the index to 3,000ish give or take a couple hundred points, and 3,500 is too sunny.

    1. My biggest concern is a slog for 6 quarters, whether it meets the definition of recession or not. My own guess is inflation goes down quickly. With a heinous narrow house majority, I cannot imagine much help from fiscal policy, in fact I fear a drag there. Monetary policy could help in that situation as long as inflation unwinds. But it is going to have to do all of the work in either direction of stimulus or further tightening.

  5. I’m starting to find myself in the more bearish camp after previously agreeing with the general consensus that the Fed would pivot hard at the first sign of recession. Now I expect the Fed to hold for longer and letting things get worse than what markets are anticipating. It’d take a serious break in the markets for the Fed to slam the emergency brake by slashing rates and I don’t see anything on the order of the great financial crisis or pandemic that would force their hand (I know, famous last words).

    I’m in tech and what concerns me is that small cap and privately held tech are just starting to experience serious pain. We’ve all heard about layoffs happening all across the tech landscape, but there is also major retrenchment in spending across the board. My spending is your revenue in the B2B tech world as everywhere else, and as everyone pulls back or goes bust, it could turn into a vicious cycle. Many of these companies were already operating at a major loss and are going to be at risk of running out of runway as everyone pulls back on spending.

    There will be some quality names that will be prime acquisition targets, but there are so many redundant and unnecessary tech tools that were kept afloat by never-ending VC money. Those faucets have turned off, and that’s a big part of why I think the FAAMG cohort will come out smelling like roses again while small cap tech continues to struggle. The FAAMG group gets to cut costs and pick up some bargains with limited downside due to their ample cashflows. They also have the upside if the Fed starts cutting rates. That’s where I feel safest heading into the new year.

    1. I’m not a FAAMG guy, but I’m with you in style, DJ.

      I hit the reset button over the past two months by selling off losses and buying into expected, winning positions in small-cap tech for 2023.

  6. FAAMG grew headcount so hugely in the last couple of years (+57% at GOOG, etc) that the 1% layoffs announced so far are barely a scratch on the necessary cost-cutting. Compare to CRM’s announced 10% cut.

  7. Walt, you set a good table! You do a great job of delivering and managing this site. This comment is directed to you, and all of our colleagues in the Heisenberg community!

    Thank you most kindly to all who share here their earnest desires to grow wealth and well-being. We all benefit when you express your perceptions and convictions. It’s a great pleasure to interact with Walt, and everyone in this community that seeks to chart a path to greater market understanding and discovery. Anyone of us can throw darts and pick stocks. But to have a broader view of the implied risks in certain market conditions and be able to make reasonably intelligent decisions about where and how to invest is an acquired skill.

    Of course, time is a teacher. And my broker has some good resources. But in parallel, I know that I have expanded my perspective here, and I am a better investor for it. Thanks very much to Walt, and to all of you here, for taking the time to share your thoughts and ideas in the Heisenberg Report.

    Good luck, happy new year, and cheers to Walt, and to all members of our community!

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