Morgan Stanley's Mike Wilson Says the Earnings Recession is Worse Than You Think | #472

Episode Summary

Executive Summary: In this episode of the MedaFavor Show, Mike Wilson, Chief U.S. Equity Strategist at Morgan Stanley, discusses his bearish outlook for U.S. equities, attributing recent price action to global liquidity rather than fundamentals. He predicts an earnings recession with S&P 500 earnings around $195, below consensus, and favors operational efficiency as a key factor. Wilson also highlights opportunities in non-U.S. markets, real assets, and sectors like industrials and financials, while cautioning against over-reliance on consensus forecasts.

Main Topics: Bear Market Dynamics and Global Liquidity (Priority: 5/5): Wilson explains that recent market moves are driven by global liquidity from the Bank of Japan and China's reopening, not fundamentals, creating a 'hall of mirrors' for investors. Earnings Recession Outlook (Priority: 5/5): Wilson forecasts S&P 500 earnings at $195 for the year, significantly below the street average of $210-$215, and expects further downward revisions. Operational Efficiency as a Key Factor (Priority: 4/5): Wilson identifies operational efficiency—companies that effectively convert revenue to profit—as the most favored factor in the current market environment. Inflation and Its Impact on Stocks (Priority: 4/5): Wilson argues that inflation is now positively correlated with stock prices due to its effect on earnings growth, marking a shift from the past 30 years. Sector and Geographic Preferences (Priority: 4/5): Wilson favors industrials, financials, commodities, and some technology names in the U.S., and sees greater opportunities in emerging markets, Europe, and Japan. Fixed Income and Real Assets (Priority: 3/5): Wilson recommends short-duration fixed income for safety and sees real assets like commodities as underpriced and entering a secular bull market. Consensus Forecasting and Career Risk (Priority: 3/5): Wilson criticizes over-reliance on guidance from the Fed and companies, advocating for contrarian views when consensus seems misaligned with fundamentals.

Key Arguments: Bear markets are confusing, with price action driven by non-fundamental factors like global liquidity. The earnings recession is in early stages; S&P 500 earnings will fall to $195, below consensus of $210-$215. Operational efficiency is the key factor: companies with lower inventory-to-sales, CapEx-to-depreciation, and labor costs outperform. Inflation is now positively correlated with stock prices, as it drives earnings growth. The U.S. dollar is likely to weaken, leading to capital redistribution to non-U.S. markets. Real assets like commodities are underpriced and in a secular bull market due to infrastructure and energy transition spending. Consensus forecasts are too reliant on guidance; contrarian views offer opportunities when models disagree.

Data Points: S&P 500 Forward 12-Month Earnings Peak: $240 - Peaked in June 2022, now down to $223. Wilson's S&P 500 Earnings Forecast: $195 - Base case for 2023; could be as low as $180 if recession occurs. Street Consensus S&P 500 Earnings Forecast: $210-$215 - Sell-side strategist consensus. Potential Downside for Stocks: 10-15% - If earnings fall to $195 and valuations stay; 20-25% if valuations also contract. Fed Funds Rate: 5% - Wilson is surprised the Fed reached this level without a major crisis. U.S. Dollar Decline: 10% - Decline from October 2022 highs, indicating capital leaving the U.S.

Pivotal Quotes: "Bear markets are like a hall of mirrors designed to confuse investors and take their money." — Mike Wilson: Describing the confusing price action in bear markets driven by non-fundamental factors. "I don't listen to this stuff. I mean, not because I'm such a great forecaster, but I know that's not going to be the answer. So, and I'm not going to make any money if I'm just following whatever the consensus view is." — Mike Wilson: Explaining his contrarian approach to consensus forecasts and guidance. "This is a fat pitch." — Mike Wilson: Referring to his conviction on earnings being too high relative to consensus, based on his models.

Implications: Investors should prepare for further downside in U.S. equities due to an earnings recession, focus on operational efficiency, and consider diversifying into non-U.S. markets and real assets. Over-reliance on consensus forecasts may lead to missed opportunities.