Morgan Stanley’s Mike Wilson still thinks earnings estimates are too optimistic. He’s also convinced that equities have benefited from a false optic around the Fed’s efforts to promote regional banking stability and an “improvement” in global liquidity since October.
These are familiar arguments, and I’ve recapped them here on innumerable occasions. I’m compelled to note, up front, that any explanation for buoyant (or resilient) equities is incomplete without an account of concurrent developments in options land, systematic investor cohorts and the vol-targeting universe.
On Monday, Wilson juxtaposed the price action headed into Q1 results with equities’ behavior ahead of the last three reporting seasons, when stocks weakened into earnings as estimates came down, only to rally as companies cleared the lowered bar. This season, stocks traded firm into earnings because, according to Wilson, investors are anticipating a trough.
“Based on current consensus forecasts, S&P 500 Q1 2023 EPS growth is expected to come in at -9% YoY while Q2 is expected to be better at -4% [and] H2 2023 is expected to grow high single digits,” he wrote. “With that kind of progression in expected EPS growth, it is not surprising that investors have been unwilling to sell into Q1 results as they believe this is as bad as it gets.”
Wilson doesn’t think this is as bad as it gets, though. If you ask Morgan Stanley’s US equities team, the trough for earnings growth won’t come until the third or fourth quarter this year.
Beyond that, Wilson said stocks are probably trading higher “due to increased liquidity from the Fed/FDIC to deal with last month’s bank events and deposit flight.” That’s not QE, and Wilson has said as much on any number of occasions, but in his view, “it has provided some lift to the S&P 500 that would not have been there in the absence of emergency actions.”
The red annotations with the arrows, although hard to make out, read “Injection of reserves by Fed/FDIC” and “Increase in TGA as tax bills are paid.”
So, if you ask Wilson, “the irony” of March’s bank drama is that it “has kept asset prices higher than they would have been otherwise via this ‘perception is reality’ liquidity dynamic.” Of course, bears generally believe last month’s events will lead invariably to tighter credit conditions and thereby serve as a drag on overall growth.
Speaking of liquidity, Wilson also reiterated the familiar notion that overall global liquidity has improved enough since October to keep stocks supported. Global M2 in dollar terms inflected higher late last year, thanks to a weaker USD, China and Japan.
Again, this is a familiar argument. I covered it extensively here.
As Wilson put it Monday, “since the S&P 500 is likely the highest quality and most liquid risk asset in the world, it’s no surprise that it would benefit from [any liquidity] tailwind.”
To support that thesis further, he cited poor market breadth, and underperformance for small-caps and regional banks. Morgan Stanley struggles to identify a historical instance of the Russell 2000 and regional lenders underperforming the S&P to the extent they are currently at the onset of a new bull market.
Ultimately, Wilson’s conclusion was as familiar as his rationale. “When forward EPS growth goes negative (as it is today), the Fed is cutting rates, not hiking [but this] Fed has been hamstrung by inflation, making this cycle a historical anomaly in this respect,” he said. That’s “a near-term headwind for equities,” in Morgan Stanley’s view, “until an easing cycle begins.”
It will take a long time for the world’s largest economy to right itself. Some companies will manage better than others. And everyone is on the same ride at the carnival. Strong stomachs will prevail.
Not to mention the world has a less stable political posture and is experiencing less than healthy economic influences on the global economy (I’m thinking of the self-serving and less than constructive influences of Russia and China).
I reckon we have a ways to go.