Michael Wilson of Morgan Stanley has been very good this cycle. Today he picks up on one of my favorite topics, the US teetering inventory mountain. As this greatest ever pile of consumption goods is destocked then over-ordering, over-employment and all manner of supply-side tensions will enter a reverse bullwhip effect and prices plus earnings crash as a global trade shock is unleashed.
While we maintain our bearish outlook, it’s no longer out of consensus. However, given the risks to growth are just emerging, it’s too early to get bullish. Biggest areas of risk remain the consumer’s ability and/or willingness to spend, margin pressure and a cyclical downturn for tech spending.
Thoughts from the road… De-rating is now a consensus view but the magnitude is still up for debate. We lowered our target P/E on both a normalized (16.5x) and short term (14.5x) basis given the risk to earnings growth that is more visible and less deniable, particularly for consumer and technology oriented companies. Energy is now the most favored sector by generalists,and inflation expectations
remain high. As such, investors view the hawkish Fed as appropriate and a major risk to equities with the put strike below 3500.
Equity clients are bearish… a necessary condition for a sustainable low, but an insufficient one. While sentiment and positioning for active institutional investors is low,asset owner clients remain heavily exposed to equities. As they reallocate, this should further weigh on equity prices. We think 3400 is a level that more accurately reflects the earnings risk ahead and expect that level to be achieved by the end of 2Q earnings season. Until then, vicious bear market rallies should be used to lighten up on the areas most vulnerable to the oncoming earnings reset.
Excess inventory is now a risk the market cares about… Earnings reports from major retailers raised cyclical concerns among investors last week as they pointed to margin pressure,a struggling low end consumer and excess inventory build. While we think the margin pressure and waning low end consumer demand dynamics have been largely understood by the market, we think the excess inventory element and the associated risk to pricing is less understood and is just now beginning to be reflected in stock prices. This has been a risk we have been flagging for the past several months as the lagging economic data has reflected this development. What’s brought this risk to the forefront recently has been corporate dialogue around inventory build during 1Q earnings season—a dynamic that’s being reflected in rising inventory/sales growth spreads across S&P industries in 1Q.
Our consumer survey shows consumers plan to cut spending due to high prices… We ran a survey of ~2,000 US consumers with the AlphaWise team; it showed that consumers are feeling the effects of the very high level of inflation we have been seeing. We found that 62% of individuals surveyed listed inflation as their number one concern for 2022(up from 56% 3 months ago). More than half of consumers are planning to cut back on spending over the next 6 months due to inflation and an even higher share of lower income consumers are expecting to reduce spending. The majority of these cuts are expected to come from highly discretionary categories including dining out and footwear/apparel.