“Ambiguity.”
It’s pervasive. So said Morgan Stanley’s Mike Wilson on Monday, describing the macro-market backdrop.
He’s not wrong there. Ambiguity’s a fixture of the post-pandemic environment. Indeed, uncertainty’s the defining characteristic of the 2020s so far.
Wilson also mentioned liquidity, and specifically the role liquidity played in supporting risk assets over the past four, going on five, months.
He’s not wrong there either. For example, RRP transformation continues to facilitate a painless QT, thereby heading off any funding market stress that might’ve otherwise come knocking.
So, those are the two buzzwords from Wall Street’s redoubtable bear: Ambiguity and liquidity.
“The historic rally since October has been driven largely by higher valuations rather than improving earnings,” he wrote, noting that almost all of the surge (which, you’re reminded, counts among the largest five-month SPX gains on record) was attributable to re-rating, as illustrated by the figure on the right, below.
“We attribute the equity rally to the easing of financial conditions, rise in liquidity and continued fiscal support in the context of a consensus that got too bearish last October,” Wilson went on.
By now, everyone with even a passing interest in markets can tell the story. The term premium rose sharply out of negative territory beginning in late summer when Treasury supply concerns collided with partisan gridlock inside the Beltway to trigger a US debt downgrade. The higher term premium manifested as an unfriendly bear steepener which undercut stocks. Equities bottomed and rates peaked in late October.
Then, during the first week of November, Janet Yellen cut Treasury’s borrowing estimate and tipped smaller-than-expected coupon increases while Jerome Powell indicated the Fed wasn’t likely to hike in December after all. Bond yields retreated, stocks rose and financial conditions eased dramatically. Later that month, Chris Waller tipped a dovish pivot which the Fed cemented a few weeks later at the final FOMC meeting of 2023.
The figure above tells the story through the lens of Goldman’s US financial conditions index.
Frankly, you don’t need much else if you want to explain the buoyancy of risk assets since the lows in October. And to the extent you do, AI optimism is the other catalyst.
Note also that the well-to-do are flush thanks to the equity rally, record-home values and a monthly windfall from MMF interest income, set against a low share of variable rate household debt. That’s supporting spending. The equation’s quite different for lower-income households, but since when do we care about them? (That’s dark humor. We should care about them, obviously.)
Wilson likes to talk about the ongoing tailwind from fiscal measures. And that’s fine. On Monday, he wrote that,
[B]etter-than-expected economic activity can be explained by the ongoing fiscal support. The budget deficit remains around 6-7% of GDP which is unusual in an economy that is operating close to full employment. Funding for the IRA and Chips Act programs, in particular, are driving not only spending dollars but also hiring by private construction and manufacturing companies via the subsidies offered to incent such activities.
That’s his explanation for the disconnect between macro strength and “muted earnings growth” outside of the (narrow) market leadership.
As for the persistence of elevated asset prices despite the Fed’s successful efforts to coax market pricing for 2024 rate cuts back closer to the December dot plot-implied 75bps (see the figure on the left above, which plots 2024 rate-cut pricing with the S&P’s forward multiple), Wilson says that’s just liquidity.
“We’ve remained in an environment of accommodative liquidity being provided by the reverse repo facility to help pay for the large budget deficit,” he wrote. “In our view, that liquidity has helped to elevate asset prices broadly, led by some of the more speculative areas of the equity market/asset classes.”
So, what’s the takeaway? Well, it’s a bit ambiguous. Like the macro-market backdrop. But Wilson says the dynamics which supported growth and pushed markets higher since October are “now better understood by the market,” which means “the burden is now likely on earnings and fundamentals to show more material improvement.”
So wait, infrastructure bills drive economic growth more than 1% tax cuts? But that can’t be possible because the entire politics of half of the country say that socialism for the rich is the only kind that works!
One of the more amusing arguments you’ll see made against Biden’s economic policies goes like this: “The reason the economy’s so strong is because the deficit’s so large!” It never occurs to critics that they’re effectively making the case for running large deficits.
Yeah I mean the tradeoff seems to be elevated inflation but it’s not like inflation is discouraging spending. The ultra low jobless rate means people can complain about expensive things while they are still able to afford them because there are an abundance of jobs paying a living wage now. The opposite would be no deficit, no jobs, low inflation, and a stagnant economy. That’s what has become synonymous with greatness??
We’re the opposite of my grandparents who were happy to be able to afford to buy ANYTHING. Now we’ve become so spoiled that we’ll complain that we can’t afford to buy EVERYTHING.
Call me an ignorant newbie—which I am—but I’m having a hard time understanding how everyone can be talking about a historically low jobless rate when, as an independent IT consultant of a few decades’ experience, this is most brutal job market I have ever seen, bar none, and I know a lot of people who are finding it to be similarly brutal. LinkedIn is full of people complaining about it right now.
I’m seeing jobs offering pay rates lower than I’ve seen in my field since late ’90s or early ’00s—that’s in absolute numbers, without adjusting for inflation—and upwards of 250 applicants for a single position at those rates. That’s not an exaggeration, I saw a IT job in my fairly narrow specialty paying, in absolute non-adjusted figures, less than $10/more than I made in the 90s when I had no experience, and certainly less than I was making by the early ’00s, with 270 applicants for it on Indeed alone. That may be an extreme case but I’m seeing plenty of specialized IT jobs with between 75 and 150 applicants per position.
I can’t understand how employment can be at a record high when everybody seems to be out of work. I’ve nearly a year out of work now, in which time, with my decades of senior developer and consulting skills and experience, I managed to score 2 interviews, both of which ghosted on me without ever even bothering to tell me I didn’t get the job. Every one of the small handful other prospects I’ve succeeded in getting to even respond to my resume submission ghosted before the interview.
Intuitively, these do not seem to me to be the kind of things that would happen while there’s an unusually low number of unemployed people.
I’m not doubting what I’m hearing here. I know most people on this site are knowledgeable. I’m just not able to understand, myself, a big picture where “low unemployment” equates nearly a full year now of seeing greater numbers of highly skilled people, myself included, all suffering unusually badly at the same time than I’ve seen before, in decades in this business. It just doesn’t make easy sense to me. ???
People see “help wanted” signs at fast food venues, their lunch place and supermarket. The garbage truck sports one as well. So it must be easy to find work, right?
Never mind that if you look at the fine print they are 29-hour-a-week (few benefits) split shift jobs.
Or ads that companies wanting to bring in HB-1 people must post asking for a mile long list of programing language skills for which you will be rewarded with a salary of $48,000.
Thanks for summarizing Wilson’s bearish argument. IMO, part of the reason his analysis is flawed has to do with his monolithic approach to the market by focusing on the S&P. Remove the energy sector from this analysis, as Kostin did in a recent analysis I saw, and his conclusion that earnings haven’t driven the rally becomes more tenuous. What he missed all along is the tale of two economies, one which is driven by capital spending (tech & infrastructure) and consumption, and the other economy, comprised of more debt-laden companies more sensitive to Fed rate hikes. It will be interesting to see whether A/I & infrastructure spending can continue to power the economy once/if the consumer is tapped out.