You gotta hand it to Morgan Stanley’s chief equity strategist Michael Wilson: he is persistent.
Just two weeks a week after Wilson called (again) for a “fire and ice” correction that would send stocks lower by 10%-20% in the 4th quarter, stocks continue to grind higher completely oblivious of all mounting risks including stagflation, China property, Covid, tapering, supply chain bottlenecks, soaring energy costs, rate hikes, slowing global growth, higher interest rates and so on (implicitly validating Goldman’s call for a meltup in the coming weeks), the Morgan Stanley strategist is out with a new “weekly warm-up” note, and while this time he is not making fresh recos, he is instead trying to pin the blame for the continued ascent. The culprit this time: no the Fed or massive stock buybacks (which according to Goldman amount to almost $4 billion per trading day) but retail investors.
Wilson starts with a preemptive mea culpa, telling impatient bears that last week he warned “it may take a bit longer for the Ice portion of our Fire and Ice narrative to play out” due to the potential for markets to look through the near-term supply bottlenecks and shortages as temporary; he also notes that with the Biden administration directing substantial resources toward addressing the problem, that conclusion is potentially easier to make.
Second, the MS strategist notes that the budget reconciliation process has been pushed out and is unlikely to be resolved until later this year. This in turn delays the negative earnings revisions from higher taxes dynamic which he thinks has yet to be incorporated into 2022 consensus forecasts.
In short, while earnings revisions breadth is falling from extreme levels, it isn’t falling fast enough yet to cause a deeper correction in the broader index. Also worth noting is that earnings revisions breadth is tied to FY2 estimates (i.e., CY2022) “so while forecasts may come down in the near term for supply / cost reasons, 2022 estimates could stay sticky until these issues are proven to be longer lasting and / or weaker demand appears in 1Q.” In any case, “Q3 earnings post-Financials should bring more clarity here in coming weeks” he says.
But the real reason why stocks just refuse to fall, according to Wilson, is the fact that “retail continues to be a major buyer of the dip.” Wilson points clients to a note he published two weeks ago in which highlighted that the Evergrande dip was taking longer to recover than prior dips this year; “in fact, both the primary uptrend and the 50-day moving average had finally been breached on significant volume. Could it be that the retail investor had finally run out of dry powder or willingness to buy the dip?” Fast forward to today when Wilson concedes that the answer to that question is a definitive “no.”
Looking at the first charts below, the MS strategist notes “that retail investors remain steadfast in their commitment to buying equities, particularly on down days.”
Making matters worse for bears, he point to the next two charts which shows that the correlation of buying to negative price action is trong. The bottom line—until these flows subside or reverse, the index will remain elevated even as the fundamental picture deteriorates.
What is bizarre about this conclusion is that it directly conflicts Bloomberg’s own conclusion, which writes today that amateur traders (i.e. retail) continued to head for the exits, at least when it comes to buying S&P 500 calls. Citing data compiled by the Options Clearing Corp. and analyzed by Susquehanna International Group show, Bloomberg notes that while the overall volume of call options jumped last week, in line with the equity gauge’s 1.8% rally, demand from the smallest options traders continued to go down. The average dollar premium that small-lot investors — those buying 10 contracts or less at a time — spent on call contracts fell to the lowest since June 2020. In other words, retail investors may be buying the dip but they are no longer rushing to buy calls and ramp gamma.
Whether retail is buying or not aside, one thing is clear: hedge funds are rushing back into stocks, and after scaling their exposure to the S&P in late August and September, hedge funds again turned long futures on the index in the back half of last month: “as the gauge’s selloff showed signs of easing, they boosted their net long S&P 500 futures positions to nearly 99,000 contracts, the most in a year.”
So much for technicals and fund flows, what about fundamentals?
Well, here Wilson remains as bearish as ever, writing that “the fundamental outlook continues to deteriorate… albeit not fast enough to deter those looking to play the seasonal strength in equity markets.” As noted above, earnings revisions breadth is rolling over and Wilson expects it to eventually revert back toward the zero line, if not below, between now and early next year.
Some of this is due to higher costs/supply shortages which investors seem increasingly willing to look through as temporary. Specifically, he points to how markets penalized Nike for its supply issues in September but Apple received a pass last week. One could interpret this price action as the markets’ way of saying it’s fully discounted. Such a conclusion assumes these supply / cost issues are temporary and that demand, in fact, remains robust.
Needless to say, on both counts Wilson remains more skeptical as the data “supports sustained supply chain pressures, rising costs, and the potential for weaker demand than anticipated next year.”
As he has discussed previously, one of the most predictive variables for the direction of equity markets is the PMI, shown below.
As part of his mid-cycle transition call, Wilson has been expecting the PMIs to fall back toward the low 50s as they typically do at this stage of any recovery. However, they have remained stickier on the upside than normal, particularly when compared against the regional indices. But now the bank’s internal indices are confirming PMI downside as they tend to be good leading/coincident indicators for the all important PMIs. Furthermore, it’s not just manufacturing businesses that are struggling with costs/supply issues (Exhibit 9). Services are also showing material deterioration (Exhibit 10). Whether it proves to be important for equity markets remains unknown, but Wilson says he wouldn’t bet against it. That said, the next readings aren’t due until early November and until proven one way or the other, equity markets can drift higher with the seasonals despite growing evidence the outcome will ultimately be disappointing. Of course, a meltup in November could result in double digits gains, which Wilson’s client will fail to catch if they listen to the strategist, even once he is eventually proven right.
Going back to the core topic of this post, Wilson writes that one of the more dramatic divergences he has observed recently, is the relentless buying of the dip mentality from retail investors despite the steep fall in consumer confidence.
Here we would beg to differ: consumer confidence in the economy may well be crashing, but retail investor confidence that the Fed will bail them out each and every time remains unshaken, and the only way this will ever change is if stocks do suffer a 10%, 20% or more correction. Until then absolutely every dip will be bought, precisely to boost consumer confidence because we live in a world where sentiment resulting from printing of funny money has more impact on the consumer psyche than one job prospects or wages.
Wilson does touch on some of this, noting that the consumer appears to be most concerned with rising prices rather than their job or income. This jibes with the conclusion many are making that demand remains robust and we just need to get through these supply bottlenecks and price spikes. Whatever the reason, Wilson thinks that “this remains an unresolved risk in our view” and once again we disagree: there is absolutely nothing out there that can possibly shake consumer confidence that stonks will just keep rising forever and ever, especially if we are heading into a $150 trillion “net zero”, “climate change” gauntlet which will see $2 trillion in QE for the next 30 years… you know, for grandkids.
