Our CIO and Chief U.S. Equity Strategist Mike Wilson considers
the year-end slump in U.S. stocks, and whether more
market-friendly policies can change the narrative.
----- Transcript -----
Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan
Stanley’s CIO and Chief US Equity Strategist. Today on the
podcast I’ll be discussing the weak finish to 2024 and what
it means for 2025.
It's Monday, Jan 6th at 11:30am in New York.
So let’s get after it.
While 2024 was another solid year for US equity markets, December
was not. The weak finish to the year is likely attributable
to several factors. First, from September to the end of November,
equity markets had one of their better 3-month runs that also
capped the historically strong 1- and 2-year advances. This rally
was due to a combination of events including a reversal of
recession fears this summer, an aggressive 50 basis
points start to a new Fed cutting cycle, and an election
that resulted in both a Republican sweep and an unchallenged
outcome that led to covering of hedges into early December. This
also lines up with my view in October that the S&P 500 could
run to 6,100 on a decisive election outcome.
Second, long-term interest rates have backed up considerably
since the summer when recession fears peaked. Importantly, this
100 basis point back-up in the 10-year
US Treasury yield occurred as the Fed
cut interest rates by 100 basis points. In my view, the
bond market may be calling into question the Fed’s decision to
cut rates so aggressively in the context of stabilizing
employment data. The fact that the term premium has risen by 77
basis points from the September lows is also significant and may
be a by-product of this dynamic and uncertainty around
fiscal sustainability. As we suggested two months ago, if the
change in the term premium was to materially exceed 50 basis
points, the equity market could start to take notice and hurt
valuations. Indeed, Equity multiples peaked in early-
to mid-December around the time when the term premium
crossed this threshold.
Finally, the rise in rates and the Trump election win has ushered
in a stronger dollar which is now reaching a level that could
also weigh on equities with significant international exposure.
More specifically, the US dollar is quickly approaching
the 10 per cent year-over-year rate of change
threshold that has historically pressured S&P 500
earnings growth and guidance.
All of these factors have combined to weigh on market breadth,
something that still looks like a warning. The divergence
between the S&P 500 Index as a ratio of its 200-day
moving average and the percent of stocks trading above their
200-day moving average has rarely been wider. This
divergence can close in two ways—either breadth improves or the
S&P 500 trades closer to its own 200-day moving average,
which is 10 per cent below current prices. The first
scenario likely relies on a combination of lower rates, a
weaker dollar, clarity on tariff policy and stronger earnings
revisions. In the absence of those developments, we think 2025
could be a year of two halves with the first half being more
challenged before the more market-friendly policy changes can
have their desired effects.
It's also worth pointing out that this gap between index pricing
and breadth has been more persistent in recent years, something
that we attribute to the generous liquidity provisions provided
by the Treasury and the Fed. It's also been aided by
interventions from other central banks. While not a perfect
measure, we do find that the year-over-year change in
global money supply in US Dollars is a good way to
monitor key inflection points, and that measure has recently
rolled over again.
The recent moves in rates and US dollar is just another reason to
stick with quality equities. Our quality bias is rooted in the
notion that we remain in a later cycle environment which is
typical of a backdrop that is consistent with
outperformance of this cohort and the fact that the relative
earnings revisions for this high quality factor are
inflecting higher. As long as these dynamics persist, we think it
also makes sense to stay selective within cyclicals and focused
on areas of the market that are showing clear relative strength
in earnings revisions. These groups include Software, Financials,
and Media & Entertainment.
Thanks for listening. If you enjoy the podcast, leave us a review
wherever you listen, and share Thoughts on the Market with a
friend or colleague today.
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