Our CIO and Chief U.S. Equity Strategist Mike Wilson looks at
buying opportunities approaching year-end, as U.S. trade policy
and the Fed find middle ground.
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 be discussing recent macro
events and third quarter earnings results.
It's Monday, November 3rd at 11:30am in New York.
So, let’s get after it.
Last week marked the passage of two key macro events: the meeting
on trade between Presidents Trump and Xi and the October Fed
meeting. On the trade front, the U.S. agreed to cut tariffs on
China by 10 percent and delay newly proposed tech export controls
for a year. In exchange, China agreed to pause its proposed
export controls on rare earths, and resume soybean purchases
while cracking down on fentanyl. This is a major positive
relative to how developments could have gone following the sharp
escalation a few weeks ago, and markets have responded
accordingly.
With respect to the Fed meeting, Powell suggested policy is not
on a preset course which took the bond market probability of a
December rate cut down from 92 percent before the meeting to 68
percent currently. It also led to some modest consolidation in
equity prices while breadth remained very weak. In my view, the
market is saying that if growth holds up but the Fed only cuts
rates modestly, leadership is likely to remain narrow and up the
quality curve.
Over the next 6 to 12 months, we think moderate weakness in
lagging labor data, and a stronger than expected earnings
backdrop ultimately sets the stage for a broadening in market
leadership. However, we are also respectful of the signals the
markets are sending in the near term. This means it's still too
early to press the small cap/low quality/deep cyclical rotation
trade until the Fed shows a clear willingness to get ahead of the
curve. Perhaps just as important for markets was the Fed's
decision to end Quantitative Tightening, or QT, in December.
Recently, Jay Powell has acknowledged the potential for rising
stress in the funding markets and indicated the Fed could end QT
sooner rather than later. Over the past month, expectations for
the timing of this QT termination ranged from immediately to as
late as February. Powell seemed to split the difference at last
week's meeting and this could be viewed as disappointing to some
market participants.
In order to monitor this development, I will be watching how
short-term funding markets behave. Specifically, overnight repo
usage has been on the rise and if that continues along with the
widening spreads between the Secured Overnight Financing Rate and
fed funds, I believe equity markets are likely to trade poorly,
especially in some of the more speculative areas. In short, we
think higher quality areas of the market are likely to continue
to outperform until this dynamic is settled.
Meanwhile, earnings season is in full swing and the real standout
has been the upside in revenue surprises, which is currently more
than double the historical run-rate. We think this could provide
further support that our rolling recovery thesis is under way
which leads to much better earnings growth than most are
expecting.
Bottom line, we are gaining more confidence in our core view that
a new bull market began in April with the end of the rolling
recession and the beginning of a new cycle. This means higher and
broader earnings growth in 2026 and a potentially different
leadership in the equity market. The full broadening out to lower
quality, smaller capitalization stocks is being held back by a
Fed that continues to fight inflation; perhaps not realizing how
much the private economy and average consumer needs lower rates
for this rolling recovery to fully blossom.
Last week’s Fed meeting could be disappointing in that regard in
the short run for equity markets. As a result, stay up the
quality curve until we get more clarity on the timing of a more
dovish path by the Fed and look for stress in funding markets as
a possible buying opportunity into year end.
Thanks for tuning in; I hope you found it informative and useful.
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