Our CIO and Chief U.S. Equity Strategist Mike Wilson probes
whether market confidence can return soon as long as tariff
policy remains in a state of flux.
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 on the
podcast I’ll be discussing last week’s volatility and what to
expect going forward.
It's Monday, April 14th at 11:30am in New York.
So, let’s get after it.
What a month for equity markets, and it's only halfway done!
Entering April, we were much more focused on growth
risks than inflation risks given the headwinds from AI Capex
growth deceleration, fiscal slowing, DOGE and
immigration enforcement. Tariffs were the
final headwind to face, and while most investors'
confidence was low about how Liberation Day would play
out, positioning skewed more toward potential relief than
disappointment.
That combination proved to be problematic when the details of the
reciprocal tariffs were announced on April 2nd. From
that afternoon's highs, S&P 500 futures plunged by 16.5 per
cent into Monday morning. Remarkably, no circuit breakers were
triggered, and markets functioned very well during this
extreme stress. However, we did observe some forced selling as
Treasuries, gold and defensive stocks were all down last
Monday.
In my view, Monday was a classic capitulation day on heavy
volume. In fact, I would go as far as to say that
Monday will likely prove to be the momentum low for this
correction that began back in December for most stocks; and as
far back as a year ago for many cyclicals. This also means that
we likely retest or break last week's price lows for the major
indices even if some individual stocks have bottomed. We suspect
a more durable low will come as early as next month or over the
summer as earnings are adjusted lower, and multiples remain
volatile with a downward bias given the Fed's apprehension to cut
rates – or provide additional liquidity unless credit or
funding markets become unstable.
As discussed last week, markets are now contemplating a much
higher risk of recession than normal – with tariffs
acting as another blow to an economy that was already weakening
from the numerous headwinds; not to mention the fact that
most of the private economy has been struggling for
the better part of two years. In my view, there have been three
factors supporting headline GDP growth and labor markets:
government spending, consumer services and AI Capex – and
all three are now slowing.
The tricky thing here is that the tariff impact is a moving
target. The question is whether the damage to
confidence can recover. As already noted, markets moved ahead of
the fundamentals; and markets have once again done a
better job than the consensus in predicting the slowdown that is
now appearing in the data.
While everyone can see the deterioration in the S&P 500 and
other popular indices, the internals of the equity
market have been even clearer. First, small caps versus large
caps have been in a distinct downtrend for the past
four years. This is the quality trade in a nutshell
which has worked so well for reasons we have been
citing for years — things like the k-economy and crowding out by
government spending that has kept the headline economic
statistics higher than they would have been otherwise. This
strength has encouraged the Fed to maintain interest rates higher
than the weaker cohorts of the economy need to
recover.
Therefore, until interest rates come down, this bifurcated
economy and equity markets are likely to persist. This also
explains why we had a brief, yet powerful rally last fall in low
quality cyclicals when the Fed was cutting rates, and
why it quickly failed when the Fed paused in December.
The dramatic correction in cyclical stocks and small caps is well
advanced not only in price, but also in time. While
many have only recently become concerned about the
growth slowdown, the market began pricing it a year
ago.
Looking at the drawdown of stocks more broadly also paints a
picture that suggests the market correction is well
advanced, but probably not complete if we end up in a recession
or the fear of one gets more fully priced. This
remains the key question for stock investors, in my view,
and why the S&P 500 is likely to remain in a range
of 5000-5500 and volatile – until we have a
more definitive answer to this specific question
around recession, or the Fed decides to circumvent the growth
risks more aggressively, like last fall.
With the Fed saying it is constrained by inflation risks, it
appears likely to err on the side of remaining on hold despite
elevated recession risk. It's a similar performance story at the
sector and industry level, with many cohorts experiencing a
drawdown equal to 2022. Bottom line, we've experienced a lot of
price damage, but it's too early to conclude that the durable
lows are in – with policy uncertainty persisting, earnings
revisions in a downtrend, the Fed on hold and back-end rates
elevated. While it’s too late to sell many individual stocks
at this point, focus on adding risk over the next month or two as
markets likely re-test last week’s lows.
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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