Can the U.S. equity market break out of its expected range? Our
CIO and Chief U.S. Equity Strategist Mike Wilson looks at whether
the Trump administration’s shifting tariff policy and Fed
uncertainty will continue weighing down stocks.
Read more insights from Morgan Stanley.
----- Transcript -----
Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan
Stanley’s CIO and Chief U.S. Equity Strategist. Today, I
will discuss what it will take for the US equity market to break
out of the 5000-5500 range.
It's Monday, April 21st at 11:30am in New York.
So, let’s get after it.
Last week, we focused on our view that the S&P 500 was likely
to remain in a 5000-5500 range in the near term given the
constraints on both the upside and the downside. First, on the
upside, we think it will be challenging for the index to
break through prior support of 5500 given the recent acceleration
lower in earnings revisions, uncertainty on how tariff
negotiations will progress and the notion that the Fed appears to
be on hold until it has more clarity on the inflationary and
growth impacts of tariffs and other factors. At the same time, we
also believe the equity market has been contemplating all of
these challenges for much longer than the consensus acknowledges.
Nowhere is this evidence clearer than in the ratio of Cyclical
versus Defensive stocks as discussed on this podcast many times.
In fact, the ratio peaked a year ago and is now down more than 40
per cent.
Coming into the year, we had a more skeptical view on growth than
the consensus for the first half due to expectations that
appeared too rosy in the context of policy sequencing that
was likely to be mostly growth negative to start. Things
like immigration enforcement, DOGE, and tariffs. Based on
our industry analysts' forecasts, we were also expecting AI Capex
growth to decelerate, particularly in the first half of the
year when growth rate comparisons are most challenging.
Recall the Deep Seek announcement in January that further
heightened investor concerns on this factor. And given the
importance of AI Capex to the overall growth expectations of
the economy, this dynamic remains a major consideration for
investors.
A key point of today’s episode is that just as many were overly
optimistic on growth coming into the year, they may be
getting too pessimistic now, especially at the stock level. As
the breakdown in cyclical stocks indicate, this correction
is well advanced both in price and time, having started
nearly a year ago. Now, with the S&P 500 closing last week
very close to the middle of our range, the index appears to
be struggling with the uncertainty of how this will all play
out.
Equities trade in the future as they try to discount what will be
happening in six months, not today. Predicting the future path is
very difficult in any environment and that is arguably more
difficult today than usual, which explains the high volatility in
equity prices. The good news is that stocks have discounted quite
a bit of slowing at this point. It’s worth remembering the
factors that many were optimistic about four-to-give months
ago—things like de-regulation, lower interest rates, AI
productivity and a more efficient government—are still on the
table as potential future positive catalysts. And markets have a
way of discounting them before it's obvious.
However, there is also a greater risk of a recession now, which
is a different kind of slowdown that has not been fully
priced at the index level, in our view. So as long as that risk
remains elevated, we need to remain balanced with our
short-term views even if we believe the odds of a positive
outcome for growth and equities are more likely than consensus
does over the intermediate term. Hence, we will continue to
range trade.
Further clouding the picture is the fact that companies face more
uncertainty than they have since the early days of the pandemic.
As a result, earnings revisions breadth is now at levels rarely
witnessed and approaching downside extremes assuming we avoid a
recession. Keep in mind that these revisions peaked almost a year
ago, well before the S&P 500 topped, further supporting our
view that this correction is much more advanced than acknowledged
by the consensus. This is why we are now more interested in
looking at stocks and sectors that may have already discounted a
mild recession even if the broader index has not.
Bottom line, if a recession is averted, markets likely made their
lows two weeks ago. If not, the S&P 500 will likely take
those lows out. There are other factors that could take us below
4800 in a bear case outcome, too. For example, the Fed
decides to raise rates due to tariff-driven inflation; or
the term premium blows out, taking 10-year Treasury yields above
5 per cent without any growth improvement.
Nevertheless, we think recession probability is the wildcard now
that markets are wrestling with. In S&P terms, we think
5000-5500 is the appropriate range until this risk is either
confirmed or refuted by the hard data – with labor being the most
important. In the meantime, stay up the quality curve with your
equity portfolio.
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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