In late 2014 we repeatedly explained why the so-called "gas tax savings" would not materialize and boost the economy via discretionary spending, as so many bullish economists were certain would happen, for one simple reason: soaring Obamacare premiums were soaking up all, and then some, of the savings. The result has been a steep drop in retail sales and consumer spending in 2015, one which even abovementioned economists have been forced to admit they never expected would happen, and as a result have been forced to cut their overly rosy outlook on the economy.
One such permabull is none other than Morgan Stanley's Adam Parker, who notoriously flipped from bearish to bullish several years ago, only to finally admit overnight that there are numerous cracks in his upside thesis in a report carrying the amsuing mame "Feeling Worse, But Not Sure We Can Explain It."
This is what Parker says:
Lowering 2015 EPS estimates: We were too optimistic about the magnitude of the benefit of lower oil prices and the impact this would have on 2015 earnings. We knew the sharp strengthening of the dollar a year ago and the drop in oil would have a negative impact on earnings for major sectors like energy, industrials, and materials, and that there would be some time before the areas that benefit showed the corresponding upside. However, we had thought that by Q3, the benefits of lower oil would start to lift earnings in other segments of the market. We over-estimated this. While a high percentage of companies were able to show year-over-year margin expansion, the combination of muted revenue and various negatives in industrials, energy, and materials, and less benefits from lower oil in terms of consumer spend and lower input costs, have caused us to reduce our 2015 EPS outlook. We still believe there is upside to the bottom-up consensus outlook, something that has limited precedent since forward earnings data began in 1976.
The amusement does not stop there as Parker, admitting he was wrong, decides to slam not only his own predictive "skills" but those of all his peers:
The Big Ten Conference has 14 teams, the Big 12 has 10, Utah's NBA team is the Jazz, LA's is the Lakers. Somehow we can explain these things, but we struggle to explain why people think they can forecast the market multiple, oil, dollar, and rates given so much evidence to the contrary.
Uhm... perhaps because they have clients who pay soft-dollars to hear what they want to hear, and people like Mr. Parker have been instrumental in perpetuating this mutual delusion?
So with all these mea culpa caveats in place, here is why Morgan Stanley joins JPM and Goldman Sachs in admitting there is little if any upside to the market from here.
We are lowering our 2015 S&P500 EPS estimate from $124 to $120.5. This is to both mark-to-market for weaker Q3 results and to reduce our estimates for January earnings. The consensus bottom-up number is roughly $119. This means we anticipate earnings growing just over 1% in 2015 year-over-year, not counting a net buyback of about 2.3%.
Forward earnings outlook also modestly reduced: Due to a lower base and adjusting for Morgan Stanley’s house views across all asset classes (a weaker US economic path, a stronger dollar against the euro, etc.), we are lowering our 2016 EPS from $128.5 to $125.9 and introducing our 2017 EPS at $131.4. These represent 4% growth both in 2016 and 2017, the same growth rate we previously anticipated but from a lower base. Since EPS growth in 2015 appears to be near 6%, excluding energy, and headwinds from the oil decline and the strong dollar will begin to moderate soon, our 4% earnings growth expectations heading into 2016 are potentially conservative.
Given our experts' view on the Fed’s path for the front end, and muted economic growth, we are forecasting only modest multiple expansion to 16.6x, yielding our new price target of 2175 for the S&P500 for yearend 2016. This is based on paying 16.6x our 2017 earnings estimate of $131.4 at the end of 2016, and offers low-to-mid single digit return from today’s levels on a 12-month forward basis.
Parker explains the "couple of items" that worry him:
Firstly, we think our forecast for the market is probably close to the consensus view. We think that we are likely headed for a choppy year of low returns, and suspect many others think the same – as opposed to romanticizing we are independent thinkers and then thinking the exact same thing as everyone else. Secondly, this is a less optimistic forecast than our prior views. On the one hand, as we have written in the past, we think that this will end up being a very long expansion, perhaps lasting even until 2020, as we don’t see excesses in the US consumer or corporate spending that make us particularly worried. On the other hand, our credit colleagues in particular are influencing our view that the credit metrics are starting to ring later cycle. Virtually none of my colleagues in any asset class in any region of the world feel more optimistic about their asset class heading into this planning season than they did 3-4 months ago. Everyone would probably say that now is the time, almost by definition, to be a contrarian, but we just don’t think that is the highest probability event.
Bull-bear cases: While our base case is for low-to-mid-single digit returns, we do think it is prudent to modify our bear outcome, given it was last set during the throws of the August sell-off. We are raising our bear case from 1500 to 1600, though we still feel the bear case embeds a mild recession in the US. In our bear case, earnings are down 2% this year, and 5% per year for 2016 and 2017. At the end of 2016, investors would pay just above 15x earnings for a view that earnings will be $105.2, yielding a bear case target of 1600. This is roughly 23% down from today’s levels. In our bull case, one that could materialize if fiscal stimuli are positive, positioning and sentiment are low and begin to rise, the oil and dollar headwinds turn into tailwinds, and our original estimates of these benefits turn out to be accurate but just pushed out by a couple of quarters. In this bull scenario, earnings strongly surprise in Q4 and grow 6% per year to $137.1 in 2017. If investors pay a bit less than 18x these earnings, feeling relatively better about US equities and the duration of the cycle, this yields a bull case target of 2425, unchanged from our prior forecast and offering 16% upside from today’s levels.
Which is more likely? As MS admits, "Our Bear Cases Have More Downside Than Our Bull Cases Have Upside"...
... and cites multiple expansion concerns as the catalyst for the bearish tilt:
Which sectors does Morgan Stanley, a financial firm, think will outperform? "Surprisingly" financials.
"we see low-to-mid-single digit returns as likely for 2016, with modestly more downside in the bear case than upside in the bull case. We are viewing this more as a mid-expansion period where equity returns are not strong (much like 2015 so far), and not the end of the expansion. Should investors regain confidence that the US economy and US corporate behaviors are not likely to lead to a substantial earnings correction, we think the market could begin another more meaningful acceleration path in this expansion."
And after all these latest Morgan Stanley forecasts, it's time to go back to "struggling to explain why people think they can forecast the market multiple, oil, dollar, and rates given so much evidence to the contrary."