Morgan Stanley's Mike Wilson Says We're Still in a Bull Market

0:00 Begin this out with stocks falling as crude harvests close to $100 a barrel. Mike Wilson of Morgan Stanley writing higher oil and rates remain the main risk to equities in the near term. Mike joins us now for more. Mike, good morning. Morning. It's good to see. Look. We've dealt with this now for seven months. We've dealt with it okay. Equities have been up into the right. Does that change? It's a wall of worry. You know, I mean, like, this is our call for the whole year, which is that earnings are gonna be better than people expected. It it was even better than we thought, quite frankly, and we've been derating all year. So it's it's not as if the market is ignoring all of these risks. It's just been digesting it in a way where it's not as obvious to the casual observer. Hey. The S and P hasn't really corrected. Well, it has corrected in price in price earnings multiples, and then and then the averages go up because of earnings. So the broadening out story, think we were the first ones to talk about that. And that and to me, that's really the story. It's it's this transition now. We're going from an early cycle recovery from the recession of a year ago. Okay? We had all the rotation now to the mid cycle areas, the quality rotation. That's very typical. So I I don't really see anything that's troubling to say there's some end of cycle calamity that's going on here. The market's dealing with all these risks, but we do worry a little bit in the short term about oil prices.

1:04 And what Annmarie was talking about is what's really important here. It's not about the price of oil. It's about the price of product. Okay? We don't consume oil. Okay? We consume gasoline. We consume diesel. We consume heating oil. And those prices are really, really high. The crack spreads on these products are as high as they've ever been. So it just even there's no more kinetic energy in this war, that's that spread has to narrow. And the question is, does that narrow from product prices coming down or from oil prices going up?

1:29 And it looks to me like it's gonna be oil prices going up because there's no demand destruction. Right? So you gotta you need demand destruction for that product to come down. So that's the risk in the near term. I don't think it's insurmountable. I think it's another hurdle that we can we can get over. Okay? But it's, you know, it's probably the next thirty or forty days where we're gonna to deal with this. Does it influence your sector exposure, the kind of sectors you wanna be in, the kind of sectors you don't wanna be in?

1:48 Well, we've we've used energy as a hedge. Right? So energy, you know, has had a great year this year, and I think you should continue to own energy stocks as a hedge in your portfolio because we like the quality parts of the market. So that's more of a not a sector call, but a factor call. Free cash flow, quality factors have really been working since the the beginning of June and feeding some of these early cycle lower quality areas. And then owning some energy on the other side is your hedge against oil prices going up.

2:10 So when would you know to get back in? Like, the second energy comes down and Well, we're we're not we're we're rotating as opposed to reducing our overall equity exposure. I I don't think people should be reducing their equity exposure. What they should be doing is upgrading the portfolio, which is what we've been doing, which is the S and P over foreign markets. It's, you know, quality stocks over lower quality stocks that are more vulnerable to a rise in rates, a rise in oil prices, and then having some hedges like oil maybe being underweight duration still within fixed income. I think that's probably a good place to be. And then, you know, gold and crypto are probably good hedges against inflation getting out of bounds.

2:43 Because The United States is so much of a bigger energy producer and less vulnerable, say, to Europe and countries like Japan. Do you wanna double down here? Absolutely. I mean, United States is protected from a lot of these concerns. And I would say The United States is still in control of its own narrative more than other countries because, you know, we we had the fiscal policy controls. The administration has been very forceful there. You have a you have a Fed chair and a and a, you know, secretary, treasury secretary who are very market savvy. Okay. So I I I feel like this is still the place to be. And let's not let's not get ourselves. S and P five hundred is still the highest quality, equity market in the world. So if you are nervous, Nelly, okay, you own the S and P500. Okay? Don't own long bonds. I mean, like, long bonds have been like, it's been a train wreck for five years. I mean, we've had that call for pretty consistently. And then, you know, gold and other alternative assets, think, are are are a good part of the portfolio. But we're in a bull market. Okay?

3:34 Let's not ignore that factor. We are in a bull market. Okay? The economy is fine. You know, policy is a little bit erratic. Sure. Okay. We have a war a couple wars going on. That's the that's the world. I mean, that's the world we live in. Been living in for thirty years. And and to think that we, the four of us, can sit here and say, oh, well, the market's not thinking about this. I doubt it.

3:53 Okay. The market's not aware of this stuff. You talked about the broadening out trade originally, and that was a significant call of yours. Yeah. What's the nature of the broadening out? Is this the deployment of AI that you're actually seeing getting monetized? Is this just the rest of the economy catching up after essentially being in a recession outside of AI? Yeah. It's more of the latter. So our call was really predicated on this idea that we did complete a recession a year ago, that typically when you come out of a recession, have massive operating leverage just on a little bit of revenue growth, which is what's happened. So that's probably 80% of the broadening out story that I think is still not appreciated or not understood. The second part is what you just talked about, which is that we are now seeing a transition from the enablers to the adopters. Okay? And that is happening from some of the enablers too. For example, the hyperscalers, one of the calls you made about two months ago is hyperscalers got too punished. Hey. These guys are enablers and adopters, and not all of them are good adopters. But the the the ones who are using the technology to advance their businesses to generate higher returns will do well. And then, of course, this includes companies across the entire economy. There are there are winners in the AI race, and there are losers in the AI race. We're seeing more winners pop up.

4:59 So that could be in consumer. That could be in health care. It could be in financials. And so it's it's a pretty broad trade. Do you think that you could see the broadening out continue even if you see, some real declines in not only the hyperscalers, but say the valuation the perceived valuation of the likes of OpenAI and Anthropic that are kind of huge question marks looming over the market, ahead of those impending IPOs? Well, that's a liquidity question, which I think, could come back into the forward next year.

5:24 I don't think the Fed chair is gonna be really overly tight on balance sheet going into midterms. You know, this is somewhat of a political game. Plus, he's new. He hasn't done his homework yet. But I do think in 2,027, we could see a liquidity tightening, some of which is just a massive issuance from corporate and from sovereign. So that's a '27 issue. I'm not ready to go there yet. But But I'm saying that a rate hike would torpedo this?

5:45 No. I'm not saying that at all. What I'm saying is a balance sheet tightening Oh. Could could torpedo the absorption of all the issuance that's going on across the entire economy, both equity and fixed income. When are you ready to start thinking about that 2027 dynamic? Well, we we have to write a report in November. Of course. Okay. Gotta wait. Gotta wait. For the year ahead. We we give it, Michael. You know, we can go to lunch and maybe have a, you know, a beer or two, and we can tighten now. I'm just but, mean, in all seriousness, I think it's just premature to be worrying about a, situation where we're over tightening. We're aware of it. I mean, we're we have things to monitor. I do think in the next thirty days, okay, if oil goes to $1.20, $1.30, $1.40, that's a drain on liquidity. Okay? That and and so that will tighten. So one thing we have to be clear about, the the Fed is no longer being abundant with its liquidity. They're being ample. What does that mean? Just enough to kinda keep the thing, you know, on the tracks. If for whatever reason we start to see things tighten in the next thirty days because of oil prices or because there's even more issuance, which, by the way, the corporate calendar looks pretty full for the next thirty or forty days, and there's some other, you know, just sort of apprehension to to to to buy securities, then we could that's another reason why I think we could have a correction in next thirty days. But it's a correction. It's not it's not the end of the You'll get a ton of supply on the debt side. High grade issuance this month could be another record. We had a record in June, July, and August on that front. Equity issuance as well. Equity supply. How well prepared are we to take in take down another monster IPO and maybe another one after that?

7:07 Well, we're very prepared at Morgan Stanley. Of course, you are. And, I mean but but, I mean, Wall Street as a as a body is very prepared for for issuance right now. We've I mean, this has been one of the best years since 2021. I don't see any real unwinding of that of that machinery yet. I mean, we're these deals are being absorbed, whether it's in credit or not. What I would say is that the quality of the deal matters. Okay? So we are seeing a little bit deterioration in the lower quality issuers, but whether it be fixed income or equity. So I don't think it's as wide open perhaps as it was six, eight, twelve months ago, but I do think we still have, quite a bit of, buying demand for for new issuance.