Morgan Stanley's Mike Wilson Talks Equity Trade | Bloomberg Talks

Good to see you. Good morning.

Yeah, I think you were saying it earlier. I was listening to the show. There's somebody expecting a hike, somebody expecting a cut, and we're on hold. This is what we got to get used to: with the new chair, probably not giving as much guidance, he's going to allow the market to figure it out on its own and have these differing views. We're in that adjustment period now. I think that's one reason the market's been a little choppy or even correcting in the last month or so — we're getting used to this new regime, which is going to be higher volatility, potentially in the bond market. But over time, the market's going to settle down. More estimates or wider dispersion of estimates actually leads to lower volatility in pricing over time. But we're in that adjustment period. So we think rates are lower ultimately, particularly at the back end. And we've talked about this many times: new Treasury Secretary, new Fed chair, this new Fed-Treasury accord to really anchor the back end. That's what they're focused on. They've got to get the back end down or at least anchored because you have so much debt to finance.

Yeah, I think that's right. And the market's pricing that now. So the good news is that we've already had that adjustment. That adjustment started four months ago, right? This is why precious metals have traded really poorly. The day that Warsh was announced as a nominee, the gold market peaked, and that was a sign the dollar has been stronger. So once again, the market has really gotten ahead of this.

Yeah, that's our call, basically. That was happening at the beginning of the year, then we had Venezuela and then Iran. By the way, the market priced Iran before the invasion even happened or the attacks happened because it was pretty well signaled. So that's when the broadening trade stopped. The broadening trade literally stopped the day that the attacks happened and we had the big spike in oil and then the pricing of the Fed to hike rates. Since mid-May, when we reiterated the broadening call, we had a different view than most. We thought oil prices would come down, and that has allowed Fed pricing to stabilize and the broadening trade to reignite.

Yeah, there's a symbiotic relationship between the spenders and the beneficiaries, and typically they trade in lockstep. A couple things we've been writing about for the last several months. Number one, CapEx to sales — that particular factor has been straight up since the big beautiful bill was passed. The government is incentivizing businesses to spend money today rather than later. So that CapEx to sales factor has been driving a lot of stocks higher. That looks like it's peaking now. And by the way, the hyperscaler stocks started to trade poorly about a month and a half ago into this idea. But that's not sustainable. You can't have the spender stocks trading poorly and the beneficiary stocks continuing to go straight up. Now what we saw last week, Meta announced that perhaps they're going to sell some excess capacity, maybe turn into a provider of capacity. That is a reason for these things to take a break. Also, peak rate of change on revision breadth — the memory stocks, revisions have been spectacular, but they can only go so high. So all of that's happening at the same time. I expect the hyperscalers now to stabilize. That's what's been going on the last couple of weeks. And the semiconductor stocks are going to correct. That's a good development. It doesn't mean the CapEx cycle is over, but that ebbing and flowing between the two is a natural governing factor because you can't have this divergence continue. It's unstable.

Well, we don't know for sure, but we've had three of these already, John. Since ChatGPT was announced in November of '22, we've had three of these mini cycles within the broader structural CapEx cycle. The market starts to question, 'Oh, the return on capital isn't good enough to support this kind of CapEx.' What happens then? The stocks trade poorly. Then the CEOs of those companies come out and say, 'Well, maybe we won't spend as aggressively.' And then it goes the other way. That's the dance back and forth. There is going to be a time, we don't know when, where the CapEx cycle will exhaust itself. And we will have malinvestment. We don't think that spending cycle is over because they just started raising capital in the credit market. So they're going to spend the capital. But we can have these mini cycles within the structural bull market of capital.

Well, it's doing it right now. We talk about it as a peak rate of change or trough rate of change, second derivative growth. That's exactly what's going on. There are two things we're focused on. Earnings revision breadth for the semiconductor stocks themselves are like 75%. That's about as high as it goes. We've documented that. So that's going to roll over. That doesn't mean it goes negative, but the deceleration on that can cause those stocks to correct. And then the hyperscalers will benefit if the market perceives these companies as being somewhat CapEx disciplined, that they're not going to do willy-nilly spending where free cash flow goes to zero or negative. Free cash flow expectations for some of those companies are going towards zero. That's why they've underperformed. So it's back and forth. Now in the last week and a half, the hyperscalers, some of them have started to trade better. That's a good sign that we're going to have this little correction. This could last four, six, eight weeks, something like that. And then we'll probably have the next up cycle for the semis.

They are high beta stocks. They can correct 30, 40% in a bull market. But just look at the 200-day moving average. That's probably a really good gauge. These stocks are so extended relative to those moving averages, that's how you have to think about it. Those moving averages exist for a reason. They always return to the moving averages. Does it happen in a violent way or gradually over time? We'll have to wait and see. But yeah, a 30% correction in these stocks is well within possibility. In fact, some of them already have corrected 30%.

Well, we didn't say that.

But that's part of our call too. We think this rotation is happening in a down tape.

Unlike the correction we saw in the precious metal stocks in January because they're such a small part of the index. Energy stocks had a big correction after having a great run in January and February. Now the market traded off a little bit because of the war itself. So I agree with your premise or your question: since these stocks are such a big part of the index, it's going to be really hard for the index to make any upward progress until this rotation has happened.

Oh, yeah. We're not bearish on the year end. We're still 8,000 plus for year end. We've had that call for quite a while based on the earnings story. That earnings story is very much intact. In fact, the fact that we're rotating now to some of these other areas almost confirms the thesis we've had all year: this is not just a tech story. That's a great story, but the broadening story is the story that I think people have really underestimated. The rolling recession from a year ago, this operating leverage story which is still very underappreciated.

Well, they have been. The money center banks and the capital markets banks really have been phenomenal.

And so they've started to perform, and that's been an area we've been highlighting. Now the yield curve is flattening still, having trouble re-steepening. So I think that group could pause a bit. We took that off of our list of favorites for the broadening trade this week. But ultimately, between now and year end, we do think the banks are going to do quite well because this is a strategy of the Treasury and the Fed: they want more lending going through the traditional lending sector. So while the yield curve is flattening, loan growth is accelerating. That's feeding this whole broadening out story of the economy. This is a strategy of the administration. They want a privately driven organic economic expansion, and that's what we're getting. Notwithstanding that maybe the labor market isn't as robust as some people were hoping, but that's also feeding the earnings story, because you're seeing revenue growth without a crazy need to hire a bunch of people. That's the operating leverage story 101.

Well, what I would say is that the market tends to get in front of this stuff. So what I'm trying to figure out is what it is digesting in the next 6 months. This is one of the reasons why I'm not that bullish in the short term. I think we have discounted lower oil prices at this point.

Yeah, well, it means oil prices are $70 again. So it's going to be hard to really get oil prices below that level without significant new source of oil or demand being destroyed further, which is probably not a good thing for growth. So I think this is another part of the story: the market got ahead of this in April and May. It said the rate of change on oil prices has peaked. The conflict between Ukraine and Russia continues, but to me this is back and forth and uncertain. But the market, just like tariffs a year ago, the worst part of the rate of change is now behind, and markets are always forward thinking. So I'm trying to figure out what's going to happen in 6 months, not what's happening next week.