Morgan Stanley bear Wilson: Global stock market rise not due to fundamentals, but because financial environment too loose

In the past 5 months, the MSCI Global Stock Index has risen by approximately 25%. Mike Wilson, Chief Investment Officer and U.S. Stock Strategy Analyst at Morgan Stanley, a well-known bear on Wall Street, believes that the main reason for this is the looser financial environment and the rise in valuations, rather than sustained improvement in fundamentals.

Wilson pointed out that under the Federal Reserve's latest policy stance, assuming it is no longer overly concerned about inflation or a more accommodative financial environment, commodity-oriented cyclical stocks, especially energy stocks, may be on the verge of a catching-up opportunity.

Earnings Expectations Unchanged for the Next Two Years

In his latest article, Wilson compared current valuations with those in 2021 and noted that earnings expectations for 2024 and 2025 have hardly been adjusted, making it difficult to justify higher valuations based solely on fundamentals.

In 2020, we proposed a "boom-bust" forecasting theory in response to the shift towards more reliance on fiscal policy for pandemic response. Based on expectations of strong economic recovery in 2020-2021 driving profit growth, we are optimistic about the stock market. This wave of profit growth in our expectations, coupled with the significant operating leverage effect as companies were able to reduce labor costs and other expenses due to people staying at home during the pandemic, ultimately led to the fastest profit growth rate and record profit margins in thirty years, with profit prosperity following stock price prosperity.

Supporting the rise in stock prices is not only profit growth, but also the most accommodative monetary policy in history. As the economy recovers from the pandemic, the Federal Reserve will keep interest rates at zero for the long term and continue quantitative easing throughout 2021. That year, S&P 500 profit growth exceeded 45%, reaching a historical high.

Currently, stock valuations are on par with 2021, mainly based on the improvement in growth expectations after last year's profit slowdown. Although the recent loose financial environment may signal an acceleration in profits, expectations for S&P 500 earnings per share (EPS) in 2024 and 2025 remain unchanged after the Fed took a more dovish stance in the fourth quarter.

In addition, based on the performance of the stock market in the past year, Wilson found that there are certain limitations to profit driving stock price increases. Therefore, the prices of most stocks have not yet reached the highs of 2021.

Despite the overall performance constraints of the stock market, companies that focus on operational efficiency have shown some performance, which is also crucial for the market to find sustainable growth momentum.

As a supplement, companies are increasingly committed to improving operational efficiency, which has been a key theme for us in the past two years and a hot topic discussed at our recent TMT conference. Continuously improving operational efficiency to offset cyclical headwinds and boost profit margins may become a catalyst for stock profit adjustments.

Huge Potential in the Industrial and Energy Sectors

Looking ahead, Wilson stated that the industrial and energy sectors show strong market performance potential driven by policies and technological innovation, especially after the Federal Reserve eased concerns about inflation. Resource-oriented cyclical industries, such as energy, may have opportunities for valuation repair and profit growth.

Wilson pointed out that under the Federal Reserve's latest policy stance, assuming it is no longer overly concerned about inflation or a more accommodative financial environment, commodity-oriented cyclical stocks, especially energy stocks, may be on the verge of catching up.

From the perspective of valuation and relative profit correction trends, the energy sector has shown attractiveness. It is worth noting that compared to any other industry, the energy industry has made the largest contribution to the change in S&P 500 earnings since the pandemic, yet it remains one of the most undervalued and least held areas in the market.

Given that the latest Federal Reserve interest rate decision maintained expectations of three rate cuts this year and raised economic outlook expectations, traders have felt a change in the Federal Reserve's tone: feeling increasingly confident about the path to achieving the 2% inflation target.

Moreover, during the post-meeting press conference, Powell avoided questions about whether the financial environment is too loose, which was interpreted by the market as a "buy" signal that the financial environment will not tighten in the short term