Morgan Stanley's bearish analyst Wilson: Once this indicator hits zero, Biden's fiscal stimulus will come to an end.

Renowned American stock bear and Morgan Stanley strategist Michael Wilson warned in a report released on February 18th that the concentration of the US stock market's rise is too high, with most companies facing bleak profit prospects. Meanwhile, as the Federal Reserve's overnight reverse repurchase tool balance continues to shrink, the liquidity used to support government fiscal policies is running dry.

High Nominal GDP Growth in the US, But the Real Economic Situation is Not Optimistic

Wilson pointed out that although the current performance of the US economy is good, nominal GDP growth is maintained at a high level due to inflation factors. However, this momentum is very narrow, with the top five companies dominating the market, while the profits and prices of most mid and small-cap stocks are significantly lower than the Pro UltrPro Shrt S&Pro 500.

He believes that due to inflation factors, it has become more difficult for most American companies to make profits:

Many companies find it increasingly difficult to pass on higher costs without harming sales. Therefore, the market performance shows a historic narrowing, with the top five stocks accounting for a much higher proportion of the S&P 500 market value than at the beginning of 2020.

In short, the stock market understands that the current economic situation in the US is not optimistic for ordinary companies and consumers.

Broad Fiscal Support for the Economy Reduces the Impact of Fed Rate Hikes

Wilson believes that the current situation of the US stock market is caused by both loose fiscal policy and liquidity, as well as tight monetary policy.

On one hand, the Biden administration has continuously introduced stimulus policies to support the US economy post-pandemic, and the broad fiscal support has greatly reduced the impact of Fed rate hikes:

Despite our very hot labor market, a large amount of fiscal spending continues. Since 2020, the budget deficit has averaged 9.4% of GDP.

Last year, the deficit increased from 5.4% in 2022 to 6.5%. Although this is far below the levels of 2020 (15.2%) and 2021 (10.5%), considering the Fed's efforts to lower inflation, this number is still high.

In many ways, massive government spending may be detrimental to the Fed, which also explains why the US economy has been slow to respond to consecutive aggressive rate hikes.

Reverse Repurchase Tool Hits Bottom, Broad Fiscal Support Fades

Wilson pointed out that the US government's fiscal deficit is essentially supported by the Fed's reverse repurchase tool. He believes that this stimulus policy has led to the so-called "crowding out effect," where increased government spending leads to a reduction in private investment or consumption, putting pressure on the US private sector.

As the Fed continues to shrink its balance sheet, the reverse repurchase balance has decreased by over $2 trillion since the end of 2022, and this month it has fallen below the $500 billion mark for the first time in over two years, signaling a red light for market liquidity. Wilson believes that the massive liquidity provided by reverse repurchase agreements supports the US government's stimulus policies, making it difficult for the Federal Reserve to achieve the expected effects on the labor market and inflation through interest rate hikes. As a result, the expected timing of rate cuts continues to be pushed back, and the number of rate cuts that may occur this year is constantly being revised downwards:

The hot CPI and PPI reports in the past week may raise a question: Can the Federal Reserve provide the necessary rate cuts to expand market gains before the government reduces the deficit and stops squeezing the private sector?

High interest rates are exerting a suppressive effect on interest-sensitive businesses (such as housing and automotive) and middle to low-income consumers. Many businesses are struggling to support themselves in a high-interest rate environment, leading to shrinking profits and further strengthening the concentration of market gains.

Therefore, as reverse repurchase tools hit bottom and the US government's loose fiscal policy becomes unsustainable, Wilson is also skeptical about corporate earnings in the US stock market.