While stocks have looked decidedly jittery in the past 3 trading session which have seen the VIX double from the low 20s to as high as 44 this morning, nothing can shake the conviction of Wall Street's reformed biggest former bear-turned-top bull, Morgan Stanley equity strategist Michael Wilson who this morning writes that as we follow the "typical recession paybook", the bank maintains its positive view for US equity markets because it's early in a new economic cycle and bull market; Addressing last week's modest correction - which has continued overnight - Wilson says it was "overdue & likely has another 5-7% downside. It's healthy and we're buyers into weakness with a small/midcap & cyclical tilt."
And just to prove to clients how bullish he is, Wilson is raising his 12-month, June 2021 S&P target to what would be an all time high 3,350, from the current 3,000: Our new target of 3,350 assumes a multiple of 20x forward 12- month earnings of $168 (a blend of our 2021 and 2022 estimates)." So to justify a record stock price, MS now has to look to earning 2.5 years into the future: good luck with that panning out. At the same time, Wilson's new bull and bear cases also shift higher, to 3,700 (from 3,250) and 2,900 (from 2,500), respectively:
Increases in both our target multiple and earnings forecasts are contributing roughly equally to the increased price target. Our target multiple moves higher as we factor in a lower range for rates and a normalized equity risk premium. Our earnings forecasts move higher as well, but this is largely a function of rolling them forward in time rather than a revision to growth expectations as we had already been positive on an earnings recovery. Ultimately our new risk reward range skews positively with greater upside to our bull case than downside to our bear case (Exhibit 9).
But while a new price target was to be expected with the S&P trading above 3,200 just last week, forcing Wilson to chase the market higher, it is probably more notable that Wilson remains so bullish despite clear signs that the V-shaped recovery is suddenly on shaky ground. Here is how the MS strategist justifies his conviction: "Since March, we have taken an optimistic view of US equity markets, for the following reasons:"
- Bear markets end, rather than begin, with recessions;
- the health crisis that triggered this recession has brought unprecedented monetary and fiscal stimulus that would otherwise have been impossible;
- the political pressures behind the reopening of the US economy are likely to make it faster and more durable,even if a second wave of the virus emerges;
- sentiment and positioning have remained remarkably bearish considering the size and persistence of the equity rally;and
- index prices, the equity risk premium, market breadth,and early-cycle leadership are all following the pattern seen after the 2009 bottom.
In short, Wilson summarizes "our recession playbook is working."
Perhaps, but what about last Thursday's rout which saw stock plunge the most since March? Wilson addresses this too, saying that "during the first few weeks of June, the markets did get a bit frothy and while overall positioning remained on the lighter side, pockets of speculation began to appear, particularly in certain parts of the retail community. That froth needed to be taken out and whether it was the Fed meeting representing a sell the news event;a spike in Covid19 cases in TX, AZ,and FL; or prospects that a Democratic sweep is starting to look more likely doesn't really matter." Wilson then adds that "corrections usually occur because markets are overbought while the reasons are highlighted after the fact. There are always reasons for markets to correct, or rally,and we find most of this kind of blame game after the fact is akin to Monday morning quarterbacking and not very helpful."
Well, they are not helpful to those who have been egging retail investors into a market with some of the more uneducated ones buying OTM calls and seeing near total losses. But we are confident that Mr. Wilson will be the first to advise the Robinhooders when to sell. That won't be now, however, because going back to the core question, why Wilson remains bullish, the answer appears to be because he equates the post-March surge in stocks to what happened in March 2009, when the Fed launched QE1:
Our view is that this is a much over due correction in a new cyclical bull market. As we have been discussing, the V-shaped recovery in markets is foreshadowing a V-shaped recovery in the economy and earnings. It's also following the 2009 pattern almost identically in many ways (Exhibit 1 and Exhibit 2), including the recent correction. Indeed, it's right on schedule and we suspect this correction is not over,yet. We are targeting 2,800 on the downside for the S&P 500, 8,500-8,600 for the Nasdaq 100,and 1,300 for the Russell 2000 before the bull market resumes in earnest.
Ok, but surely there is more than just some correlation is causation analysis behind the bank's bullish call? As a matter of fact, there is, with Wilson next falling back on the bank's economist team who overnight doubled-down on their prediction that after the sharpest economic collapse in history, we are about to enjoy the fastest economic recovery too, resulting in "one of the shortest recessions in history."
As Wilson writes, Morgan Stanley economists "believe this recession will prove to be the steepest but also one of the shortest on record."
We concur and while the conditions for the recession were already in place coming into 2020, the trigger was unexpected (as usual) and unique. Furthermore, the severity of the recession was man made — i.e., the lockdown. As a result, policy makers enacted unprecedented monetary and fiscal stimulus that we think will prove to be too much in the context of an economy that reopens faster and more durably than expected when these policies were enacted. The fiscal stimulus is directed right at the consumer and small/medium business which have a greater propensity to spend it in the real economy which means the velocity of money may not collapse this time as M1 expands. This all argues for a weaker USD, higher inflation and nominal GDP.Finally, the excesses of the last cycle were concentrated in the corporate sector while the consumer came into this recession in much better shape than last time. With housing and equity markets holding up, the average consumer net worth is unchanged, which means we aren't looking at a big deleveraging cycle. To the contrary, it appears the consumer wants to participate more actively in the rally as the past month has shown. What this really means is that 70 percent of the economy is able to recovery quickly, particularly with such generous government support.
But aren't we just piling bubbles upon bubbles at this point with all the previous excesses merely "swept up" under trillions more in debt? Why yes we are, but this too doesn't bother Wilson who writes that "Ironically, while the excesses of the prior cycle were concentrated in the corporate sector and shadow banks, the nature of this recession and policy response will effectively bail out these bad actors in a way that leaves them less damaged than if we were experiencing a less severe recession."
And there you have: every new asset bubble will just get an ever greater policy response, which according to MS is a sufficient reason not to worry about anything: after all, all the previous excesses will just be wiped out in the next trillion (and soon quadrillion) dollar debt monetization. And it's not like Wilson is wrong on this: Powell himself admitted that the Fed will just keep blowing the bubble bigger if it means the creation of even one low-wage job, totally oblivious of the catastrophic consequences to everyone else - and the millions of jobs that will be lost - once the current bubble bursts. More from Wilson:
One of the features of any recession and recovery is that costs are cut indiscriminately as companies try to protect cash flows. Labor is a big target given it is the single largest cost for most businesses and this is why recessions occur — layoffs lead to a contraction in GDP and sales growth. Of course, when the economy and sales recover, companies experience positive operating leverage. This time around that leverage might be even more powerful than normal given the PPP benefits available to the small and medium sized businesses that make it to the other side. Meanwhile, more generous than normal unemployment benefits to the consumer this time around means the economy (and sales) will return quickly as projected in Exhibit 5 above. The bottom line is that NTM earnings forecasts may have been cut too far, especially for smaller capitalization and cyclical companies (Exhibit7), which means the growth on the other side could be explosive."
It could be, but as we pointed out earlier, it won't be as withheld taxes confirm that the BLS is now openly making up job numbers, with May tax withholdings plunging by the most on record, even as jobs supposedly rebounded. There is no way the two are compatible. However, as usual it will take Wall Street a few months to figure out what was obvious on this website.
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So going back to Wilson's new S&P 12-month price target which is 350 points higher than before, or 3,350, he explains in some more details how he got this number, which is based on a 20x forward earnings, and "reflects an increase to our target multiple but contraction from current levels."
But isn't a 20x PE a little high for a recession (lol)? Why yes, and as Wilson admits, it is "elevated by historical standards" not to mention recession/depression standards, but he thinks the rate environment matters: "A lower rate range should boost equity valuations going forward, particularly as the equity risk premium normalizes further into the recovery. We make the core assumption that an economic recovery supports both a rise in yields and a normalized equity risk premium. As a result within our 20x, we embed an equity risk premium in the mid-300s and a US 10Y yields ~1.5%. Predicting the inputs with precision is difficult, but as Exhibit 10 shows, moderate deviations from these targets still leaves 20x as a central tendency."
Oh, and get this: just because 2021 EPS are not high enough, MS somehow has visibility 2.5 years ahead, and is now basing its S&P price target not off 2021 earnings but 2022!
While our 2021 estimates are largely unchanged, the earnings in our 12 month forward target increase as we roll the target from year end 2020 to June 2021 and focus on earnings through 1H22. It is too early to project actual 2022 earnings but a year from now the market will be pricing off of 2022 expectations. Across our bull/base/bear scenarios, our 2022 forecasts reflect the view that even by the middle of next year, the 2022 numbers will be uncertain, but will be made in a more normalized growth environment. As such, we would expect the consensus to follow its historical pattern of projecting low double digit earnings growth for "next year" (2022),and we assume a steady 12% across our scenarios.
In other words, trust the same consensus that has failed to point out to its clients that it will take the S&P 5 years to get back to 2018 EPS (as a reminder, EPS in 2019 were unchanged, and with 2020 a disaster, we will need more than just 2021 and 2022 to get back to where EPS was almost 2 years ago. Just don't tell that to Mike.
In short, tell Wilson how to get a specific number, and he will move mountains if he has to, but he will goalseek the EPS and the multiple with the ferver of the most spy first-year i-banking analyst. After all, there are Robinhooders who need to be convinced that what they are doing makes sense. And who knows, some of them will get rich enough to where they become Morgan Stanley clients eventually...