Original Release Date November 26, 2024: Morgan Stanley’s
CIO and Chief U.S. Equity Strategist Mike Wilson joins Andrew
Pauker of the U.S. Equity Strategy team to break down the key
issues for equity markets ahead of 2025, including the impact of
potential deregulation and tariffs.
----- Transcript -----
Andrew Sheets: 2024 was a year of transition for
economies and global markets. Central banks began easing interest
rates, U.S. elections signaled significant policy change, and
Generative AI made a quantum leap in adoption and development.
Thank you for listening throughout 2024, as we navigated the
issues and events that shaped financial markets, and society. We
hope you'll join us next year as we continue to bring you the
most up to date information on the financial world. This week,
please enjoy some encores of episodes over the last few months
and we'll be back with all new episodes in January. From all of
us on Thoughts on the Market, Happy Holidays, and a very Happy
New Year.
Mike Wilson: Welcome to Thoughts on the
Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief US Equity
Strategist.
Andrew Pauker: And I'm Andrew Pauker from
our US Equity Strategy Team.
Mike Wilson: Today we'll discuss our 2025
outlook for US equities.
It's Tuesday, November 26th at 5pm.
So let's get after it.
Andrew Pauker: Mike, we're forecasting a
year-end 2025 price target of 6,500 for the S&P 500. That's
about 9 percent upside from current levels. Walk us through the
drivers of that price target from an earnings and valuation
standpoint.
Mike Wilson: Yeah, I mean, I think, you
know, this is really just rolling forward what we did this
summer, which is we started to incorporate our economists’
soft-landing views. And, of course, our rate strategist view for
10-year yields, which, you know, factors into valuation.
We really didn't change any of our earnings forecast. That's
where we've been very accurate. What we've been not accurate is
on the multiple. And I think a lot of clients have also --
investors -- have been probably a little bit too conservative on
their multiple assumption. And so, we went back and looked at,
you know, periods when earnings growth is above average, which is
what we're expecting. And that's just about 8 percent; anything
north of that. Plus, when the Fed is actually cutting rates,
which was not the case this past summer, it's just very difficult
to see multiples go down. So, we actually do have about 5 percent
depreciation in our multiple assumption on a year-over-year
basis, but still it's very high relative to history.
But if the base case plays out, but from an economic standpoint
and from a rate standpoint, it's
unlikely earnings rates are going to come down. So,
then we basically can get all of the appreciation from our
earnings forecast for about, you know, 10-12 percent; a little
bit of a discount from multiples, that gets you your 9 percent
upside.
I just want to, you know, make sure listeners understand that the
macro-outcomes are still very uncertain. And so just like this
year, you know, we maybe pivot back and forth throughout the year
… as [it] becomes [clear], you know, what the outcome is actually
going to be.
For example, growth could be better; growth could be worse; rates
could be higher; the Fed may not cut rates; they may have to
raise rates again if inflation comes back. So, I would just, you
know, make sure people understand it's not going to be a straight
line no matter what happens. And we're going to try to navigate
that with, you know, our style sector picks.
Andrew Pauker: There are a number of new
policy dynamics to think through post the election that may have
a significant impact on markets as we head into 2025, Mike. What
are the potential policy changes that you think could be most
impactful for equities next year?
Mike Wilson: Yeah, and I think a lot of
this started to get discounted into the markets this fall, you
know, the prediction polls were kinda leaning towards a
Republican win, starting really in June – and it kind of went
back and forth and then it really picked up steam in September
and October. And the thing that the markets, equity market, are
most excited about I would say, is this idea of deregulation. You
know, that's something President-elect Trump has talked about.
The Republicans seem to be on board with that. That sort of
business friendly, if you will, kind of a repeat of his first
term.
I would say on the negative side what markets are maybe wary
about, of course, is tariffs. But here there’s a lot of
uncertainty too. We obviously got a tweet last night from
President-elect Trump, and it was, you know, 10 percent
additional tariffs on certain things. And there’s just a lot of
confusion. Some stocks sold off on that. But remember a lot of
stocks rallied yesterday on the news of Scott Bessent being
announced as Treasury Secretary because he's maybe not going to
be as tough on tariffs.
So, what I view the next two months as is sort of a trial period
where we're going to see a lot of announcements going out. And
then the people in the cabinet positions who are appointed along
with the President-elect are going to look at how the market
reacts. And they're going to want to try to, you know, think
about that in the context of how they're going to propose policy
when they actually take office.
So, a lot of volatility over the next two months as these
announcements are kind of floated out there as trial balloons.
And then, of course, you also have the enforcement of immigration
and the impact there on growth and also labor supply and labor
costs. And that could be a net negative in the first half of next
year. And so, look, it's going to be about the sequencing. Those
are the two easy ones that you can see – tariffs of some form,
and of course, immigration enforcement. And those are probably
the two biggest potential negatives in the first half of next
year.
Andrew Pauker: Mike, the title of our
Outlook is “Stay Nimble Amid Changing Market Leadership,” and I
think that reflects our mentality when it comes to remaining
focused on capturing the leadership changes under the surface of
the market. We rotated from a defensive posture over the
summer to a more pro-cyclical stance in the fall. Talk about our
latest views when it comes to positioning across styles, themes,
and sectors here.
Mike Wilson: Yeah, I mean, you know, you
have to understand that that pivot was not about the election as
much as it was about kind of the economy, moving from the risk of
a hard landing, which people were worried about this summer to,
soft landing again. And then of course we got the Fed to,
you know, aggressively begin a new rate cutting cycle with 50
basis points, which was a bit of a surprise given, you know, the
context of a still decent labor markets.
That was the main reason for kind of the cyclical pivot, and
then, of course, the election outcome sort of turbocharges some
of that. So that's why we're sticking with it for now.
So, to be more specific, what we basically did was we went to
quality cyclical rotation. What does that mean? It means, you
know, we prefer things like financials, maybe industrials, kind
of a close second from a sector standpoint. But this quality
feature we think is important for people to consider because
interest rates are still pretty high. You know, balance sheets
are still a little stretched and, you know, price levels are
still high.
So that means that lower quality businesses -- and the stocks of
those lower quality businesses -- are probably a higher risk than
we want to assume right now. But going into year end first and in
2025, we're going to stick with what we've sort of been
recommending. On the defensive side. We didn't abandon all of
them – because of , you know, we don't know how it's going to
play out. So, we kept Utilities as an overweight because it has
some offensive properties as well – most notably lever to kind of
this, power deficiency within the United States. And that, of
course with deregulation, a new twist on that could be things
like natural gas, deployment of, you know, natural gas resources,
which would help pipelines, LNG facilities potentially, and also,
new ways to drive electricity production.
So, with that, Andrew, why don't you maybe dig in a little bit
deeper on our financials column, and why it's not just, you know,
about the election and kind of a rotation, but there's actually
fundamental drivers here.
Andrew Pauker: Yeah, so Financials remains
our top sector pick, following our upgrade in early October. And
the drivers of that view are – a rebounding capital markets
backdrop, strong earnings revisions, and the potential for an
acceleration in buybacks into next year. And then post the
election, expectation for deregulation can also continue to drive
performance for the sector in addition to those fundamental
catalysts. And then finally, even with the outperformance that
we've seen for the group, over the last month and a half or so,
relative valuation remains on demand – and kind of the 50th
percentile of historical levels.
So, Mike, I want to wrap up by spending a minute on investor
feedback to our outlook. Which aspects of our view have you
gotten the most questions on? Where do investors agree and where
do they disagree?
Mike Wilson: Yeah, I mean, it's sort of
been ongoing because, as we noted, we really pivoted, more
constructively on kind of a pro-cyclical basis a while ago. And
the pushback then is the same as it is now, which is that
equities are expensive. And I mean, quite frankly, the reason we
pivoted to some of these more cyclical areas is because they're
not as expensive. But that doesn't take away from the fact that
stocks are pricey. And so, people just want to understand this
analysis that, you know, we did this time around, which kind of
just shows why multiples can stay higher.
They do appreciate that, you know, things can change. So, you
know, we need to be, you know, cognizant of that. I would say,
there's also debate around small caps. You know, we're neutral on
small caps; we upgraded that about the same time after having
been underweight for several years.
I think, you know, people really want to get behind that. It's
been a; it's been a trade that people have gotten wrong,
repeatedly over the last couple years trying to buy small caps.
This time it seems like there may be some more behind it. We
agree. That's why we went to neutral. And I think, you know,
there are people who want to figure out, well, why? Why don't we
go overweight now? And what we're really waiting for is for rates
to come down a bit more. It's still sort of a late cycle
environment. So, you know, typically you want to wait until you
kind of see the beginnings of a new acceleration in the economy.
And that's not what our economists are forecasting.
And then the other area is just this debate around government
efficiency. And this is where I'm actually most excited because
this is not priced at all in my view. There's so much skepticism
around the ability or, you know, the likelihood of success in
shrinking the government. That's not really what we're, you know,
hoping for. We're just hoping for kind of a freezing of
government spending. And it's so important to just, to think
about it that way because that's what the fiscal sustainability
question is all about, where then rates can stay contained. But
then if you take it a step further, you know, our view for the
last several years has been that the government has been
essentially crowding out the private economy, and that really has
punished small, medium businesses as well as many consumers.
And so, by shrinking or at least freezing the size of the
government and redeploying those efforts into the private
economy, we could see a very significant increase in
productivity, but also see a broadening out in this rally. I
mean, one of the reasons the market's been; equity market's been
so narrow is because is because scale really matters in this
crowded out, sort of environment.
If that changes, that creates opportunity at the stock level
and that broadening out, which is a much healthier bull market
potential.
So, what are you hearing from investors, Andrew?
Andrew Pauker: Yeah, I mean, I think the
debate now, in addition to the factors that you mentioned, is
really around the consumer space. A lot of pessimism is in the
price already for consumer discretionary goods on the back of –
kind of wallet share shift from goods to services, high price
levels and sticky interest rates in addition to the tariff risk.
So, what we did in our note this week is we laid out a couple of
drivers that could potentially get us more positive on that
cohort. And those include a reversion in terms of the wallet
share shift actually back towards goods. I think that would be a
function of lower price levels. Lower interest rates – our rate
strategists expect the 10-year yield to fall to 355 by year end
2025. So that would be a constructive backdrop for some of the
more interest rate sensitive and housing areas within consumer
discretionary.
Those are all factors that watching closely in order to get more
constructive on that space. But that is another area of the
market that I have received a good amount of questions on.
Mike Wilson: That's great, Andrew. Thanks a
lot. Thanks for taking the time to talk today.
Andrew Pauker: Thanks, Mike. Anytime.
Mike Wilson: And thanks for listening. If
you enjoy Thoughts on the Market, please leave us a review
wherever you listen and share the podcast with a friend or
colleague today.
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