The Next Stage of the Market Correction — Transcript

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1. 0:01Welcome to Thoughts on the Market. I'm
2. 0:02Mike Wilson, Morgan Stanley CIO and
3. 0:04Chief US Equity Strategist.
4. 0:06Is the end of this equity market
5. 0:08correction in sight? Today on the
6. 0:09podcast, I'll share what I think could
7. 0:11turn the tide.
8. 0:13It's Monday, October 26th at 11:30 a.m.
9. 0:16in New York. So, let's get after it.
10. 0:19The correction that began in June is now
11. 0:21well advanced beneath the surface.
12. 0:24But, I believe the high-quality S&P 500
13. 0:26Index may still have some unfinished
14. 0:28business.
15. 0:29Until that plays out, I don't think we
16. 0:31can say the adjustment is complete.
17. 0:34The real question to ask, how bad does
18. 0:36it have to get before it gets better?
19. 0:40We've described this correction as a
20. 0:41classic mid-cycle transition.
21. 0:44The peak rate of change in earnings
22. 0:45revisions arrived right on schedule,
23. 0:47about a year after the recession trough.
24. 0:51And the market responded the way that it
25. 0:52usually does.
26. 0:54Early cycle leaders with more operating
27. 0:56and financial leverage started to
28. 0:57underperform, while higher-quality,
29. 1:00asset-light, services-oriented business
30. 1:02moved to the front.
31. 1:04This quality rotation is now well
32. 1:06understood though, and positioning has
33. 1:08followed it.
34. 1:09Ironically, the final step is usually a
35. 1:11convergence between the resilient
36. 1:12high-quality S&P 500 Index and the
37. 1:15weaker breadth beneath.
38. 1:17We may already be seeing the beginning
39. 1:19of that meeting in the middle.
40. 1:21If the index does move lower, I believe
41. 1:247,100 to 7,200 on the S&P 500 is where
42. 1:27the correction should find material
43. 1:29support.
44. 1:31The reason I believe we'll ultimately
45. 1:32have a positive resolution to this
46. 1:34transition is that a lot of damage has
47. 1:36already occurred.
48. 1:38Roughly 60% of the Russell 3000 stocks
49. 1:41are down more than 20% since June.
50. 1:44And the hit has been even more severe in
51. 1:46early cycle areas like semiconductors,
52. 1:48autos, consumer cyclicals, and capital
53. 1:52goods.
54. 1:54At the same time, hedge fund positioning
55. 1:55has come down meaningfully, leaving us
56. 1:57near the lows for the past 12 months.
57. 2:00That's encouraging, but sentiment
58. 2:02overall is not yet at the kind of
59. 2:04extreme that typically marks a durable
60. 2:05low.
61. 2:07I think we're close, but we're not quite
62. 2:08there.
63. 2:10So, what gets us there?
64. 2:12I see three clearing events ahead.
65. 2:15The first is AI.
66. 2:16Investors are questioning the eventual
67. 2:18return on capital, the cost of capital,
68. 2:21and whether credit markets can fund all
69. 2:23the spending that has been promised.
70. 2:25Over the next few weeks, the market will
71. 2:27need to absorb more supply, and lower
72. 2:29quality players may continue to see
73. 2:31wider spreads and even lower stock
74. 2:33prices.
75. 2:35I view the supply as the event itself.
76. 2:38Once it clears, the risk should begin to
77. 2:40fade.
78. 2:41Semiconductors remain at the center of
79. 2:42this concern and may offer a good
80. 2:45benchmark to monitor for the broader
81. 2:46market correction.
82. 2:48Specifically, I see another 10 to 15%
83. 2:51lower for the semiconductor index in the
84. 2:52mid-November.
85. 2:55The second clearing event is the midterm
86. 2:56elections.
87. 2:58Markets dislike uncertainty, and this
88. 3:00election has plenty.
89. 3:02A blue wave is not a surprise anymore,
90. 3:04though.
91. 3:05The larger overhang is what may happen
92. 3:07after the vote, including the
93. 3:09possibility of a renewed military
94. 3:11escalation in Iran.
95. 3:14I have no special edge in forecasting
96. 3:16geopolitics, but I do know that these
97. 3:18kinds of shocks often create very good
98. 3:20buying opportunities.
99. 3:23Historically, post-midterm returns have
100. 3:24been very strong. So, I would be ready
101. 3:26to embrace a sharp downdraft in stocks
102. 3:29in the days and weeks around election
103. 3:30day.
104. 3:32The third and most important clearing
105. 3:34event is liquidity.
106. 3:36Financial conditions have tightened
107. 3:37sharply through a combination of higher
108. 3:39rates, slower balance sheet growth,
109. 3:42stronger demand for capital, and higher
110. 3:44energy prices.
111. 3:46The tightening is beginning to resemble
112. 3:482018,
113. 3:50and it's not far from what we
114. 3:51experienced in 2022,
115. 3:53despite very modest tightening from the
116. 3:55Fed so far.
117. 3:56In fact, the market may be doing the
118. 3:58Fed's tightening for it.
119. 4:00And if that tightening begins to create
120. 4:01funding stress or destabilizes credit
121. 4:04markets, the Fed and Treasury have tools
122. 4:06to respond.
123. 4:07The question is whether conditions need
124. 4:09to deteriorate further before they act.
125. 4:13Bottom line, I think the correction in
126. 4:14equity markets that began in June is in
127. 4:16the final stages.
128. 4:18But the final stage can be very
129. 4:19uncomfortable. We may need still one
130. 4:21more index level drawdown and bout of
131. 4:23volatility. Or one more moment when
132. 4:26investors conclude that something is
133. 4:27broken.
134. 4:29That may be exactly what clears the path
135. 4:31for the Fed to pivot and the next leg
136. 4:32higher for stocks.
137. 4:34For now, I want to stay with quality
138. 4:36stocks that have already corrected more
139. 4:38than the index in areas like capital
140. 4:40goods.
141. 4:41More importantly, if these clearing
142. 4:42events create a sharp downdraft, I would
143. 4:44view it less as a reason to run from
144. 4:46risk and more as an opportunity we've
145. 4:48been waiting for it to buy. So, be
146. 4:50ready.
147. 4:52Thanks for tuning in. Hope you found it
148. 4:54informative and useful. Let us know what
149. 4:56you think by leaving us a review. If you
150. 4:58find thoughts on the market worthwhile,
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152. 5:02out.
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