With Morgan Stanley's Adam Parker having left the investment bank to continue his career at Eminence Capital, it was up to his replacement, Michael Wilson to come up with the Initiation of coverage report for the "Classic Late Cycle." So, in keeping a stiff upper lip, and breaking away from the gloom that appears to have recently gripped his colleagues over at Goldman Sachs, Wilson had no choice but to keep a stiff upper lip and keep the Punch Bowl full (to paraphrase Bill Dudley's famous March 30 speech).
So, projecting a remarkable dose of optimism at a time when dramatic changes are in store for not only the Fed's balance sheet but the global credit impulse which is now negative, Wilson, who until recently was Morgan Stanley's Chief Investment Officer of Wealth Management, writes that "although optimism is a late cycle phenomenon, history tells us the best returns often come at the end. It has taken eight long years to get here, but Wall and Main Street are finally starting to feel a bit better about the future."
What alse comes at the end is the crash, and those tend to make both Wall and Main Street feel a bit worse about not only the future but also the present.
In any case, the basis for MS' optimism is the economic recovery - which alas is entirely missing in the hard data, which tumbled after the NFP print to the lowest level in a year - and the Trump reflation euphoria - which the bank may have missed faded about a month ago and has been rapidly contracting to pre-election levels - and uses that to extrapolate a move as high as 3,000 in the S&P, or a 30% blow off top.
Or, as Wilson puts it, "the end of the cycle is often the best. Think 1999 or 2006-07. In a low-return world, investors cannot afford to miss it." And while "not missing it", investors will preferably buy stocks using a Morgan Stanley broker,right?
And while we commiserate with Wilson for putting it all on the line in his first report, and timestamping his wildly bullish call in a report that will be passed around for years to come, especially if this is the top-tick, here is the summary of his outlook just to help with the .
The cyclical upturn that began a year ago has less to do with President Trump and more to do with the global business cycle that bottomed in 1Q2016. Trump simply “turbocharged” the cycle and stoked animal spirits on Wall and Main Street, with tangible effects on the real economy and markets. The title of our year-ahead outlook as CIO for Morgan Stanley Wealth Management on January 1st (see excerpt at end) was “Are You Ready for Euphoria?”– based on Sir John Templeton’s four stages of the investment cycle: "Bull markets are born in pessimism, grow in skepticism, mature in optimism and die in euphoria."
What follows next may be one of the most memorable, in retrospect lines, ever written in a research report:
The end of the cycle is often the best. Think 1999 or 2006-07. In a low-return world, investors cannot afford to miss it.
So... buy stocks just at the peak of the bubble, as was the case in both 1999 and 2007, and pray for the best? Don't worry, though, Morgan Stanley will tell you just when to sell, before it all crashes.
Think 2000 and 2008.
The humor continues:
Equity valuation remains undemanding in a low interest rate world. Equity risk premiums (ERPs) have been exceptionally elevated in the post-crisis era of lower growth and inflation, but we may be leaving that era, which means ERPs can and should normalize. Our 12-month base case S&P 500 target is 2700.
Secular Stagnation may be over, further supporting our expectation for falling equity risk premiums. Productivity may have bottomed, fueled by the end of trends that caused the slower growth in the first place: consumer overindebtedness (housing), the oil bubble's tax on consumers, war on terror, demographics, and bad policy (regulation, lack of fiscal/monetary coordination).
Exceptionally loose financial conditions encourage the shift toward investor euphoria. Meanwhile, our proprietary institutional and retail data suggest US equity positioning is not extreme, and market technicals are in very good shape.
To all investor who can read that with a straight face, congratulations. And perhaps just to lend credibility to his forecast, here is the matrix of Wilson's recommendations, which sees a worst case of 2,100 in the S&P, a base case of 2,700, or over 300 points higher by EOD, and a blow off top forecast of not less then 3,000 or 30% higher from current levels.
And just to cement his "credibility", Wilson shows another chart demonstrating he is totally proficient with goalseeking in Excel sensitivity tables:
MS then narrows down its preferences to the following sectors:
Our sector/style preferences reflect our pro-risk, late-cycle thesis. Financials, Industrials, Energy, and Technology are all overweight. We are underweight Real Estate, Telecom, and Staples. We are neutral Health Care, Materials, Consumer Discretionary, and Utilities. We have a preference for small/mid caps.
An appropriate trade idea here would be to do the opposite of what MS recommends.
Perhaps most importantly, here is what Wilson believes are the risks to his call:
- We are late cycle and the Fed is further along than appreciated. This tightening cycle began in 2014 with the tapering of QE, which means there may be less headroom for actual rate hikes this cycle than assumed;
- Commercial Real Estate and Autos are canaries in the coal mine that could spill over into broader credit markets;
- Oil prices fall further and/or take longer than expected to recover—the Energy sector is the single largest incremental driver of S&P 500 earnings growth this year;
- ECB tapering is not expected but it could happen this summer when political risks diminish in Europe.
As an amusing aside, as part of his "initiating coverage" report, Wilson shares a brief comment "on what we endeavor to provide as Morgan Stanley's US Equity Strategist."
First, the role of US Equity Strategist at Morgan Stanley has quite a storied history. As a 27-year veteran of the firm, no one has more respect for that history or the position itself. We will do our best to live up to it. Second, our philosophy about equity markets is fairly simple – get the rate of change on earnings growth right; pay attention to valuation when it matters but don’t obsess over it; appreciate the importance of sentiment and positioning and always respect what the market is telling us. In short, trust one’s fundamental work, but verify it with the market's signals. Third, we only exist to serve you, our client. To that end, I hope that my dual role of US Equity Strategist and Chief Investment Officer, embedded in a best-in-class global Research Department and informed by a leading institutional equity and wealth management business, will provide the strategy team – and our clients - with unique and profitable insights.
Unique profitable insights like calling an up to 30% spike at a time when the market is currently trading at 20x forward operating earnings according to Goldman...
... a number which would rise to 25x under Morgan Stanley's bullish scenario.Clearly when Wilson says "pay attention to valuation when it matters but don’t obsess over it" it is more focused on the latter.
Finally, while investors are welcome to trade like it is 1999, don't forget what happened just one year later...