Monthly Investment Perspectives: Video Michael Wilson Chief Investment Officer Morgan Stanley Wealth Management Morgan Stanley & Co. Chief US Equity Strategist Morgan Stanley & Co. April 17, 2017
Monthly Investment Perspectives: Video On Wednesday, April 12, 2017 Chief Investment Officer Michael Wilson hosted the Global Investment Committee Monthly Investment Perspectives call/webcast to discuss the current market conditions and outlook. GLOBAL INVESTMENT COMMITTEE Page 2 of 7
Good afternoon, everyone. It's Mike Wilson, chief investment officer for Morgan Stanley Wealth Management and MS & Co. Welcome to April's Monthly Investment Perspectives. It does look like we're into another one of these periods where folks are getting a little bit concerned about geopolitics, whether it be in North Korea or Russia or has to do with the French elections, which are coming up. And then of course this concern around Donald Trump, President Trump and the administration's ability to get legislation done. The economic and earnings recovery that began is still going. You know, it started a year ago, and actually it's surprising on the upside. In fact, I'm going show some data today, which shows that the breadth of the data that we're getting, not just in the US but globally, is about as strong as we've seen since 2009. I know there's some concern about the first quarter in the US, but we think there's actually a snapback in Q2 that's going to be pretty strong. Some of the leading indicators are suggesting that as well. As far as the target we have now for the US, we're looking for a target of 2,700. That is 15% upside. I was very surprised over the course of the last couple days. I did some spots in the media. You know, folks are saying, "Wow, 15% upside," and they acted as if this was some booming target. Now, that is the high target on the Street, but at the same time it's 15% upside. We're not talking about 20%, 30%, 40% upside. 15% is not a crazy number. And so, it speaks volumes to kind of where sentiment is today, which is fairly, you know, pessimistic about, you know, a potential upside. And I think a lot of it has to do with valuation. We're overweight, financials, industrials, technology and energy. It's a nice balance between growth and value. We still have value bias in some of our models because some of the value stuff has underperformed this year. So, we're probably not going to re-weight that necessarily until we could see some catch up, but we do think it's going to be a more broad market in terms of value and growth. Last year, value definitely outperformed dramatically. This year growth has outperformed. We think there'll be some catch-up as we go into the middle part of this year as people start to feel better about that synchronous growth that's happening in the global economy. The one market that's really underperformed is Japan. It's been probably the weakest performing market year to date in local currency terms. You know, the dollar has been weak against the yen. So, in dollar terms, it's actually been pretty good. The yen is going to start to weaken again this quarter. Japan has had the biggest earnings upside in the fourth quarter, and we think in the first quarter, once we get the results to come in. And therefore Japan looks like it has probably the best risk-reward for the rest of this year. We're standing just tall on that call. We have not backed off of that. And that's the one market that's sort of underperformed in here. So, if you're looking for a laggard, well, Japan is the laggard. And for those of you who need a top up, those positions or kind of maybe got out of those positions last year, this could be an opportunity to do that. And I would just point out that, you know, with the French elections coming up, April 23 is the first round. There is risk of hedging going into that, and so the European markets have been very strong. For folks looking for an opportunity to buy European stocks, we think you might get an opportunity over the next two weeks as people get nervous finally about this French election, which is coming to a conclusion. So, let's talk about the data itself. This is the global economic and inflation surprises combined. So, why do we do that? We think it's important because, first of all, this goes back to 2006. And you can see we haven't had this kind of level really ever in the history of this index. Why are we looking at economic growth and inflation together? Because that's a pretty good proxy for nominal GDP. Nominal GDP is basically real GDP plus inflation. So, this is surprises for inflation and economic growth. This is a proxy for nominal GDP. Not real GDP. Nominal GDP. And that gets back to the point I made earlier around this idea that nominal GDP drives revenue growth. The other important point I want to make is that every region, okay, is turning up. Unlike 2013, where it was kind of a mixed bag. We didn't really get this global impetus. This is something our economists have been talking about as well, which is that we're seeing more synchronicity in the data globally, which means this could be a more sustainable recovery. So, this is very important from both a nominal standpoint and from a sustainably standpoint. And this is why we believe valuations can continue to expand. All right, next 12-month earnings forecast. This is bottoms up. This is the way we look at it. It's a little bit unorthodox. We think it's right. And we think this is the best way to think about what markets are pricing in. Forward earning estimates have continued to move higher. 122 at the low. Today it's 135. So, that's a pretty big increase. Importantly, growth rates have also been increasing and we're going to see about 10% growth this quarter. And we should probably continue to see about 10% growth on a year-over-year basis for the next couple quarters. We feel very good about the next few quarters. GLOBAL INVESTMENT COMMITTEE Page 3 of 7
Beyond September and into December, that's when we're going have to start really, you know, pressing sort of the flesh a little bit with respect to understanding what the, you know, where the trigger points are for a potential rollover next year in terms of rate of change, but either way we think we have plenty of time on the clock for growth to continue to be supportive of higher equity prices. This is a new model we introduced in our initiation. It's our leading indicator. And it tends to do a very good job of forecasting actual last 12-month earnings per share growth. So, right now, the leading indicator's suggesting that we are moving towards a 20% revenue growth/earnings growth number on a year-over-year basis sometime later this year. Today we're just breaking through zero. We're going to be probably close to 10 by the first quarter. And remember, the forecast kind of goes like this. So, this is a pretty good sign this is a macro leading indicator for earnings growth that suggests that the consensus numbers are not too high. And that's what we're really trying to figure out are the consensus numbers achievable or are they too high? And we think right now even though they're showing pretty good growth for the rest of this year, we think they're achievable based on some of our macro leading indicators, and we think that's a very important point. If you look at the last 40 years, going back to 1976, you could see the equity risk premium moves all over the place. And so, sometimes it gets overvalued, like down here in 1987. We had a negative equity risk premium over negative 200 basis points. Obviously, the TMT bubble was another period where valuations just got extreme. Beyond September and into December, that's when we're going have to start really, you know, pressing sort of the flesh a little bit with respect to understanding where the trigger points are for a potential rollover next year in terms of rate of change, but either way we think we have plenty of time on the clock for growth to continue to be supportive of higher equity prices. This is a new model we introduced in our initiation. It's our leading indicator and it tends to do a very good job of forecasting actual last 12-month earnings per share growth. So, right now, the leading indicator's suggesting that we are moving towards a 20% revenue growth/earnings growth number on a year-over-year basis sometime later this year. Today we're, just breaking through zero. We're going to be probably close to 10 by the first quarter. And remember, the forecast kind of goes like this. So, this is a pretty good sign this is a macro leading indicator for earnings growth that suggests that the consensus numbers are not too high. And that's what we're really trying to figure out; are the consensus numbers achievable or are they too high? And we think right now even though they're showing pretty good growth for the rest of this year, we think they're achievable based on some of our macro leading indicators, and we think that's a very important point. If you look at the last 40 years, going back to 1976, you could see the equity risk premium moves all over the place. And so, sometimes it gets overvalued, like down here in 1987. We had a negative equity risk premium over negative 200 basis points. Obviously, the TMT bubble was another period where valuations just got extreme. Okay, that's not where we are. We're up here at 332 basis points. But, what I really want you to focus on here is that I think more importantly we are leaving a period here of excessively high equity risk premiums. This is not just a US phenomenon. This is happening in Japan. It's happening in India. It's happening in parts of Europe now, Spain being a good point. Potentially, the UK and now maybe even the EU after some of these elections get passed we could see more unification. Brazil seeing major political change. So, there's a real push going on around the world for more fiscal support taking advantage of these abnormally low interest rates to fund it. That makes a lot of sense. And so, the equity risk premiums are just normalizing, right? The normal equity risk premium over the last 100 years is 242 basis points. Today, we're at 330. So, why can't we go back to just a normal equity risk premium? So, let's talk about the Trump trades because this seems to be the other concern now with the market, is that President Trump and the Republicans are essentially a lame duck administration already. They can't get anything done. They're bickering with each other. There's definitely some truth to that. This sort of repeal and replace Obamacare didn't get done, so that means none of the good stuff's going to get done either. We need tax cuts, infrastructure, deregulation. So, we've-- looked at these three trades specifically. We view the small caps as a sort of proxy for tax cuts; we view deep cyclicals as a proxy for infrastructure spending; and we view the banks as a proxy for deregulation. This chart is all relative to the S&P 500. Now, you'll notice that going back to last year, small caps and the infrastructure stocks bottomed in February at the lows of 2016. And they've been in an uptrend since. The financials here didn't bottom until post-brexit. And that makes sense because that's when everything kind of bottomed in terms of rates, everything else, and this fear around deflation. Now, here's the interesting part. The election, okay, they all got a pretty good pop in the election. These are the three biggest beneficiaries of the Trump Republican win. Small caps, banks, infrastructure spending and related stocks. Right? Since then, though, they've basically given back almost 100% of their performance. The banks have only given back about 50%, but the infrastructure stocks and the small caps have given back about 100% of their relative outperformance since the election. GLOBAL INVESTMENT COMMITTEE Page 4 of 7
This is just a nice dashboard to look at the things that we're focused on. First is a relative earnings revision, second is valuation, third is positioning and sentiment, and fourth is relative strength. But, then we also have this sort of macro environment, which is more of a subjective input. What's the macro environment mean for these different sectors? But, this is what we're going to be using. There are a lot of data behind this. But, right now we've got this sort of barbell between value and growth. And the biggest driver here is really relative earnings revisions. Three of the four sectors have pretty constructive relative earnings revisions. As you can see on the bottom, it's mostly negative relative earnings revisions. That has a very heavy weight in our sector selection. This is a very powerful chart, in my view, what's going on. The markets are recognizing all the things that we've been talking about, which is that there is a shift. Right? That policy's changing. The secular stagnation may be over and, by the way, buying a bond with a negative real yield is a bad deal. People are now actually shifting money and shifting assets in that direction. This is an important chart for a lot of the asset owners in the world, not just individual investors, but pension funds, endowments, etc. And so, we believe the next secular bull market for stocks relative to bonds because over time stocks versus bonds goes up. This was the secular bear. We are now into the secular bull, not only in terms of stocks, absolutely, but stocks versus bonds. And we think these moves recently confirm that point. Thanks for joining us for April s Monthly Investment Perspectives. We hope to see you in May. Have a great day. GLOBAL INVESTMENT COMMITTEE Page 5 of 7
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