Morgan Stanley
  • Thoughts on the Market Podcast
  • Feb 22, 2021

An Eye on Bull Market Surprises

With Mike Wilson
U.S. Equities Research for Investors


Welcome to Thoughts on the Market. I'm Mike Wilson, Chief Investment Officer and Chief U.S. Equity Strategist for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the latest trends in the financial marketplace. It's Monday, February 22nd, at 11:30 a.m. in New York. So let's get after it.

With February now almost over, things are really looking up. First, fourth quarter earnings proved to be terrific for most companies. With 419 companies in the S&P 500 reporting so far, earnings per share have come in 18% higher than the consensus estimate. Sales have been just 3% higher on average, suggesting our operating leverage theme is really playing out. More specifically, unemployment remains high, but the government support to help out means many companies have not seen a precipitous fall in revenue. Instead, fourth quarter sales actually grew 1% year over year. When combined with a lower unemployment cost and other operating expenses, profit margins have moved to near all-time highs. In short, the recession is over for corporate profits.

Second, after a slow start, the vaccination process has picked up nicely. In addition, there is some evidence that the first shot of the vaccine could provide 75% effectiveness against symptoms of any kind. Meanwhile, new cases are falling more rapidly than expected, and several leading health experts are even saying we may achieve herd immunity as early as April. This is a big change from just a few weeks ago.

Finally, Congress is working on another fiscal stimulus to support the economy until we are finally rid of this disease. Latest talks suggest this bill could be as big as $1.5 trillion, which is 50% greater than the one passed at the end of last year when COVID cases and hospitalizations were raging towards all-time highs.

It should be no surprise that equity markets have continued to do well under these circumstances and recent developments. In fact, markets have barely exhibited any two-way risk this year outside of a brief sell off at the end of last month, as several hedge funds were forced to reduce leverage.

At this point, it seems like nothing can slow this bull market. However, that's exactly when surprises usually arise. We see two potential risks to be thinking about as we exit February. First, is the risk associated with interest rates rising sharply as bond markets simply catch up to what other asset prices are already reflecting. Such a rise would put pressure on some of the most richly priced stocks that have done so well. Second is the risk that some of the positive operating leverage that we've been witnessing in company earnings reports starts to go in reverse. Supply for many key economic inputs has been destroyed over the past year, and in some cases permanently. This is already starting to cause some problems for certain supply chains.

Bottom line, the combination of higher interest rates and peaking earnings revisions could prove to be difficult for the markets to handle in the short term. Such a correction, if it were to arise, would be welcome at this point, as sentiment and positioning have reached extreme levels.

With this macro backdrop, we continue to favor areas in the market that are reasonably priced or can benefit from rising rates and inflation. Areas like banks, materials and energy. We also favor reopening beneficiaries in the consumer and business services sectors, as markets begin to digest a faster return to normal activities.

Thanks for listening. If you enjoy the show, please leave us a review on Apple Podcasts and share Thoughts on the Market with a friend or colleague today.

U.S. equities markets have continued to perform well, fueled by upbeat earnings and vaccination news. However, that’s often when surprises arise.

Each week, Mike Wilson offers his perspective on the forces shaping the markets and how to separate the signal from the noise. Listen to his most recent episode and check out those of his colleagues from across Morgan Stanley Research.

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