“Reality” is coming for 2023’s early stock rally.
That’s according to Morgan Stanley’s Mike Wilson, who last week warned that the bank’s earnings model suggests profits are likely to contract more sharply than analysts and investors expect.
In a Monday note, Wilson reiterated the point. “Cost growth is rising faster than sales growth for ~80% of S&P 500 industry groups [and] as a result, margin pressure is worsening,” he said.
As a reminder, profit growth for corporate America is expected to be negative this quarter for the first time since the onset of the pandemic.
The Nasdaq 100 is off to its best start to a calendar year since 1999 despite a hodgepodge of cautious commentary from management, (including a weak Azure guide from Microsoft) and a disastrous update from Intel. Wilson attributed stocks’ recent run higher to the “January effect” and “short covering after a tough end to December and a brutal year.”
Although he did acknowledge that the macro fundamentals have improved on several fronts, he said that’s old news. Regular readers will recall that Wilson timed the October/November stock rally almost perfectly. “At that point, the S&P 500 was trading 500+ points lower with a P/E that was almost 20% lower than today,” he said Monday, referencing a tactical long call from October that Morgan Stanley exited last month.
“What’s happening now is just another bear market trap, in our view, as investors have been forced once again to abandon their fundamental discipline in fear of falling behind or missing out,” Wilson warned.
The chart above is simple, but poignant. The header says it all: Earnings growth is on the brink of turning negative and the Fed is still hiking rates.
It’s worth noting that Wilson is hardly alone in doubting the rally. Last week, JPMorgan emphasized that January’s surge was in part attributable to mechanical flows, which may soon run out of gas.
Wilson was unbowed and unequivocal on Monday. “We double down on our thesis, which is now out of consensus again, based on sentiment and positioning,” he said. “With month-end this week taking some pressure off active managers to keep chasing this rally that is based on a narrative that started in October from much lower valuations, it’s time to fade it.”
Matador was feeling bearish that he could handle the Bull
H-Man, the chart does suggest that when EPS slides, the Fed will pause, then pivot and ease. The question becomes how far down the EPS sliding board before the pivot?