Over the summer, Morgan Stanley's chief equity strategist Michael Wilson reprised a familiar role when he emerged as Wall Street's most bearish analyst, predicting that stocks are overvalued, that the market is overstretched and that it would all come tumbling down in a 10-20% "fire and ice" correction. Not even a begrudging, modest hike to his year-end S&P price target from 3,900 to 4,000 could dent his conviction that stocks are headed for a unhappy fourth quarter. And while the modest market turmoil at the start of the month prompted him to turn even more vocal on calls for an imminent market slide, so far that has not happened and last week Wilson blamed the retail traders' Pavlovian reflex to buy each and every dip without any fear.
The answer: absolutely not, and while the ongoing ramp in stocks has clearly dented his timeline for a painful market drop, Wilson still expects a "colder winter but later arrival."
As Wilson writes in his latest weekly note, over the past few weeks he had discussed the increasing probability "for a colder winter but a later start than previously expected. In other words, our Fire and Ice narrative remains very much intact," but as he now admits, the timing is a bit more uncertain for Ice.
Having said that, with inflation running rampant in both consumer and corporate channels, Wilson expects the Fed to formally announce its tapering schedule at next week's meeting "with perhaps a more hawkish "tone" to convince markets they are on the job." In other words, the Fire portion of his narrative (higher rates driven by a less accommodative Fed spurs multiple compression) is very much in gear and is a focus for investors.
So while we wait for Wilsons' Ice to be unleashed, and with much attention on rising inflation now from both investors and the Fed, Wilson shift attention to the ongoing macro growth slowdown and when we can expect it to bottom and reverse course.
Shifting away from markets, Wilson focuses on the bigger picture and reminds readers that he has been expecting "a material slowdown in both economic and earnings growth amid a mid cycle transition. The good news is so does the consensus as illustrated by the sharp declines in 3Q21 economic growth forecasts (Exhibit 1). While 4Q21 GDP forecasts have also declined, the expected growth rate is higher than 3Q—i.e., the street expects growth to reaccelerate from here (Exhibit 2). Most have blamed the Delta variant, China's crack down on real estate or power outages around the world for the economic disappointment in 3Q with the assumption all three will get better as we move into year end and 2022.
Needless to say, the bearish Wilson disagrees with that assumption: he thinks "the more important driver of the slowdown has been a mid cycle transition to slowing growth from post-recession peak growth...which is not over yet. In our view, it would be intellectually inconsistent to think that the mid cycle transition slowdown won't be worse than normal given the greater than normal amplitude of this entire economic
cycle so far—from a GDP growth, earnings growth and policy response standpoint."
To buttress his variant take, Wilson then recalls his "lonely" position over a year ago when he argued for much greater growth and operating leverage for earnings given the large government subsidies for corporations as the unemployed were supported like never before. Fast forward to today, when we simply find ourselves in the exact opposite side of the argument relative to consensus, but for the same reasons: "Since we believe consensus missed that insight last year, it seems possible they could be missing this side of the argument as well."
The bottom line, according to Wilson is that "the growth slowdown will be worse and last longer than expected—i.e., well into the first half of 2022 as the payback in demand arrives with the sharp y/y decline in personal disposable income" a thesis we wholeheartedly agree with as we have been noting recently the vast majority of Americans have already run out of "excess savings" which helped to propel the economy for much of 2021, a fact that was reinforced by recent BofA card spending data which showed that lower income cohorts had seen a spike in their credit card usage as their debit cards had run dry.
Incidentally, Wilson also agrees and writes that "while many have argued the large increase in personal savings will allow consumption to remain well above trend, it looks to us like personal savings have already been drawn down to pre-COVID levels."
But what about pushback that this measure of personal savings doesn't include the enormous rise in stock, real estate and crypto assets over the past year. Here, again, Wilson points out the obvious: that asset wealth is very concentrated in the top quintile of the population. In fact, the lower end consumer is really starting to hurt according to a recent Harvard / NPR survey highlighted by Wilson.
Meanwhile, the MS strategist highlights a few tidbits regarding the recent fall in consumer confidence (Exhibit 4) which is not just about the Delta variant, as many commentators have implied:
- 38% of households across the nation report facing serious financial problems in the past few months.
- There is a sharp income divide in terms of those experiencing serious financial problems: 59% of those with annual incomes below $50,000 report facing serious financial problems in the past few months, compared with 18% of households with annual incomes of $50,000 or more.
- These serious financial problems are cited despite 67% of households reporting that in the past few months, they have received financial assistance from the government.
- Another significant problem for many U.S. households is losing their savings during the COVID-19 outbreak. Nineteen percent (19%) of U.S. households report losing all of their savings during the COVID-19 outbreak and not currently having any savings to fall back on.
- At the time the Centers for Disease Control and Prevention’s (CDC) eviction ban expired, 27% of renters nationally reported serious problems paying their rent in the past few months.
- When it comes to their children’s education, 69% of households with children in K- 12 last school year say their children fell behind in their learning because of the COVID-19 outbreak, including 36% of all households with children in K-12 reporting their children fell behind a lot.
- Thinking about the upcoming school year, 70% of households whose children fell behind last school year believe it will be difficult for children in their household to catch up on education losses from last school year.
Putting it all together, a stubborn Wilson refuses to capitulate on his bearish call, and instead argues that the market simply refuses to read the warning signs that the economy is sending. As a result, he digs in and says that "with the Fed tightening policy, it's likely multiples will continue to fall as they typically do at this stage of the recovery. Therefore, from here the key variable for stocks will be the trajectory of NTM EPS forecasts." On that score, he notes that there has been a flattening out of estimates, but NTM EPS has continued to rise at a slower rate. However, as we will note in a subsequent post, earnings revisions breadth - a key leading indicator - is now falling rapidly for almost all sectors. And given that revisions breadth is a very good leading indicator for NTM EPS, it's only a matter of time before NTM EPS begin to decline according to Morgan Stanley, for a variety of reasons including: higher costs, supply issues and taxes to a payback in demand that should begin in 1Q.
Nevertheless, even Wilson acknowledges that until these numbers actually come down, equity markets may be given the benefit of the doubt as retail equity inflows continue to remain robust. In short, "Winter is coming but we may have to wait until December or January for the cold air."