Our CIO and Chief U.S. Equity Strategist Mike Wilson explains how
his outlook on earnings and valuations give him a constructive
view on U.S. equities for the next 12 months.
Read more insights from Morgan Stanley.
----- Transcript -----
Mike Wilson: Welcome to Thoughts on the
Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief U.S.
Equity Strategist.
Today on the podcast I’ll discuss where there is the most push
back to our Mid-year outlook and why I remain convicted in our
generally constructive view on U.S. equities for the next 12
months.
It's Monday, June 2nd at 11:30am in New York.
So, let’s get after it.
To briefly summarize our outlook, we have maintained our 6500
12-month price target for the S&P 500 this year despite what
has been a very volatile first five months – both in terms of
news flow and price action. Part of the reason we didn’t change
this view stems from the fact that we expected the first half to
be challenging for U.S. stocks but to be followed by a more
favorable second half. Much of this was related to our view that
the new administration would pursue the growth negative part of
their policy agenda first. This played out -- with their focus on
immigration enforcement, spending cutbacks and tariffs. In
addition to these policy adjustments, we also expected AI capex
to decelerate in the first half after such fast growth last year.
All of these factors conspired to weigh on both economic growth
and earnings revisions.
Second, the way in which tariffs were rolled out on Liberation
Day was a shock to most market participants, including us,
and served as the perfect catalyst for what can only be described
as capitulation selling by many institutional investors. That
capitulation has set the stage for the very reflexive snap back
in equity prices that is also supported by a positive rate of
change on policy, earnings revisions breadth, financial
conditions and a weaker U.S. dollar.
The main push back to our views centers on our constructive
earnings outlook for high single digit growth both this year and
next and our view that valuations can remain elevated at 21.5x
forward Earnings. On the earnings front, our calendar
year earnings estimates already incorporate
a mid-single-digit percent hit to bottoms-up consensus
forecasts. Second, our Leading Earnings
Indicator which projects Earnings Per Share growth 12
months out is suggesting a sideways consolidation in growth in
the high single-digit range over the next year.
Third, a weaker dollar, elements of the tax bill and AI-driven
productivity should be incremental tailwinds for earnings that
are not in our model. Fourth, we have experienced
rolling recessions for many sectors of the private economy for
the last 3 years, which makes growth comparisons
easier. Finally, and most importantly, the rate of change on
earnings revisions breadth has inflected higher from a very low
level after a year-long downturn.
On valuation, our work shows that if earnings growth is
above the long-term median of 7 percent and if the fed funds rate
is down on a year-over-year basis, it's very rare to see multiple
compression. In fact, Price Earnings multiples have expanded 90
percent of the time under these conditions to the tune of 9
percent over a 12- month period. Therefore, in some ways
we’re being conservative with our forecast for the S&P
500's price earnings ratio to remain flat at current
levels over the next year.
With respect to our favorite valuation metric, the
equity risk premium, it’s interesting to note that in the week
following Liberation Day, the Equity Risk Premium reached
the same level we witnessed in the aftermath of the 9-11 shock in
2001 and even exceeded the risk premium reached during the
Long-Term Capital Management crisis in 1998. Both episodes
resulted in 20 percent corrections to the S&P 500 much like
we experienced this year only to be followed by very strong
equity markets over the next year.
The bottom line is that I remain convicted in both our earnings
forecast for high single digit earnings growth for this year and
next; and my view that valuations can remain elevated in this
classic late cycle expansion of slower economic growth that
typically elicits interest rate cuts from the Fed.
Thanks for tuning in; I hope you found it informative and useful.
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you find Thoughts on the Market worthwhile, tell a friend or
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