55 pages of Mike Wilson. Just imagine.
For market skeptics, Christmas arrives every year in November when Wilson, the standard-bearer for well-reasoned, logical bear takes, releases his year-ahead outlook for US equities.
Wilson’s 2024 outlook, published on Monday, is extensive. To the extent it’s possible to extract one takeaway, it’s probably this: In the near-term, challenges persist, but over the medium-term, an earnings recovery is likely.
At the outset, Wilson conceded that although the earnings recession he spent the better part of 2022 predicting did in fact pan out, he was “too bearish in terms of expected magnitude of the decline.” Although Wilson pretty clearly thinks it’s too early to declare the US corporate profit recession over, S&P 500 EPS grew 4% YoY in Q3, 10% excluding energy.
Wilson praised America’s mega-caps that for “an outstanding job on cost discipline” and lauded the titans’ ability to grab market share in an economy propped up by lingering fiscal largesse.
Now, it’s a matter of whether the rest of the market catches up to the mega-caps or whether “the laggards will eventually overwhelm the leaders’ ability to keep delivering” given macro headwinds.
The average stock, Wilson reminded market participants, is “slightly down” in 2023, while seven out of 11 sectors are likewise underwater. As the figures above show, 2023’s equity market performance counts among the narrowest ever.
Wilson reiterated that “healthy bull markets” aren’t defined by lackluster breadth, but noted that narrow returns do “accurately reflect the challenging earnings dynamics” that may “persist into early 2024 before a sustainable earnings recovery takes hold.”
By the time the dust clears next year, Wilson expects S&P 500 EPS to grow 7%, but it won’t necessarily be a smooth ride. In the very near-term, Morgan Stanley’s US equities team “remains cautious… as high frequency earnings revisions and macro data deteriorate, interest rates remain restrictive and breadth continues to break down.”
He flagged poor breadth again and again, both in the context of the price action and earnings revisions. “We expect these dynamics to persist in the near-term and act as a headwind for performance, particularly given the increasingly cautious macro environment noted by companies, a vigilant Federal Reserve and fading fiscal support,” Wilson cautioned.
The good news is, Wilson expects earnings growth to stage a recovery over the course of 2024, as tipped by the bank’s leading earnings indicator.
Recall that the latest installment of the Fed’s Senior Loan Officer Opinion survey suggested that although credit conditions remain very challenged, the environment improved incrementally over the last three months. The figure on the right (above) plots what market participants generally consider to be the “headline” print from the survey (i.e., the share of banks tightening standards on C&I loans to large and middle-market firms) with YoY EPS growth.
“History shows margin pressure is the main driver of earnings recessions as it takes time for companies to right size expenses in line with slowing top line growth [but] once that happens, and demand begins to recover, positive operating leverage resumes and drives margin expansion and earnings growth,” Wilson wrote.
That view (that eventual expense right-sizing, demand recovery and the resumption of positive operating leverage will revive earnings growth) is part and parcel of Morgan Stanley’s EPS growth forecasts.
In addition to 7% EPS growth in 2024, Wilson sees earnings growing 16% in 2025.
The strong 2025 earnings growth outlook factors in some help from A.I. “Our historical analysis of periods where we saw (1) rising tech spend as a percent of total fixed investment, (2) rising productivity growth, and (3) rising profit margins on a one-year lagged basis implies that tech-driven productivity growth could add an additional 30bps to 2025 net margin at the large cap equity level,” Wilson said.
That’s the upshot of Wilson’s outlook, in 600 words. Wilson used a lot more words than that. As noted here at the outset, bears were treated to 55 pages of Mike on Monday.
Everyone who’s anyone across the financial media, blogosphere and finance-focused social media will surely publish or otherwise mention/detail the specifics behind Wilson’s base, bull and bear cases for US equities. In light of that, I’d be remiss not to mention them too. They’re below, as originally detailed by Wilson, presented without further comment other than to say that, as ever, Wilson’s analysis is trenchant — right or wrong, he deserves plaudits for that.
Base Case Price Target for December 2024: 4,500 Near-term uncertainty should give way to an earnings recovery as we progress through next year. For December 2024, we forecast a 17.0x P/E multiple on 12-month forward EPS (2025) of US$266, which equates to a 4,500 price target ~12 months from today. Our 2024 earnings forecast of US$229 (+7%Y) assumes 4-5%Y top-line growth in addition to modest margin expansion as labor cost pressures ease. Our 2024 EPS estimate is also consistent with output from our leading earnings models, which show a recovery in growth next year as well as our economists’ expectations for growth next year. Our updated 2023 earnings forecast moves closer to our prior bull case, which brings our 2024 EPS growth rate down even though our 2024 estimate is little changed at US$229. 2025 represents a strong earnings growth environment (+16%Y) as positive operating leverage, further cost efficiencies and tech-driven (AI) productivity growth lead to margin expansion. On the valuation front, we forecast a ~190bp equity risk premium (currently ~100bp); combined with our rates strategists’ 10-year forecast, this equates to a 17.0x forward P/E multiple at the end of next year (currently 18.1x). The justification for the higher equity risk premium is that as rates will have fully normalized by then, so should the ERP.
Bull Case Price Target for December 2024: 5,050 In our 5,050 bull case, the market puts a 17.5x P/E multiple on forward (2025) EPS of $289. This outcome represents a stronger EPS growth backdrop for 2024 (+13%Y)—top line growth is mid-to-high single digits and margin expansion is ~70-80bp. Structural tailwinds including AI have a more immediate impact on margins and earnings next year. Risk premiums compress as a significant cyclical recovery takes hold, more than offsetting any rise in rates that comes amid a stronger economic backdrop. This leads to modest multiple expansion relative to our base case. Leadership likely broadens out in this outcome and we’d expect strong relative outperformance from the more cyclical areas of the market. That said, we’d also expect the largest mega cap weights to exhibit strong performance as their earnings are enhanced by a healthier economy where more companies are fully participating, unlike today. The Fed can still pivot to a more accommodative policy stance next year despite a strong earnings growth backdrop. Growth in 2025 looks similarly strong (+15%Y) driven by margin expansion and tech-fueled productivity gains.
Bear Case Price Target for December 2024: 3,850 In our 3,850 bear case, the market puts a 16.5x P/E multiple on forward (2025) EPS of $234. This outcome reflects a weaker earnings environment in 2024 (-7%Y) as the earnings recession persists well into next year amid more significant margin compression. The lagged effects of higher interest rates impact consumption across income cohorts and the labor market shows more visible signs of weakening. 2024 may see some interest rate relief as growth slows but it’s not enough to offset risk premium expansion as cyclical risks build. After a deeper earnings recession in 2024, the EPS growth profile improves dramatically in 2025 as positive operating leverage returns in a meaningful way.
