Morgan Stabley bearing it up:
Over the past few weeks, we’ve been spending a lot of time with investors discussing and debating our mid-year outlook. Here are the highlights:
First,investors are definitely more receptive to the mid-cycle transition narrative that we introduced a few months ago. There’s an acknowledgement that something has changed in the market, because more investors are struggling to make money consistently as leadership flip-flops day to day. This is consistent with the typical mid-cycle transition as the market struggles to find the next consensus trade.
Second, while investors are warming up to our mid-cycle transition thesis, they don’t agree that USequity valuations need to fall by another 15%, as we suggest. Though this view is based on historical mid-cycle transitions, many we speak with think that this time is different because the Fed and other central banks are committed to staying dovish for longer than normal. We don’t doubt the Fed’s resolve but believe that a more dovish Fed today means it will need to tighten faster later. We also think the equity market understands this and will discount it by proactively taking valuations lower through the equity risk premium channel, rather than waiting for cues from the bond market. More importantly, it’s already happened in the most expensive and lower-quality parts of the equity market, and we think this de-rating will eventually reach the S&P500 (Exhibit1).
Third, many investors believe we are too conservative on earnings growth for next year. Since we were the first to call for a V-shaped recovery and extraordinary operating leverage last year, we’re taking this particular pushback with a grain of salt. Instead, we remain concerned that after the most positive earnings revisions quarter on record, next year’s consensus forecasts are now above what our analysis suggests is achievable for the first time since the recovery began. More specifically, we think margin assumptions are too high given headwinds from inflation and taxes that have not been baked into estimates. The market should start to factor them in via lower valuations.
