Morgan Stanley

Morgan Stanley analyst Mike Wilson is out with a new call for the market to test new lows with more disappointing economic data.

Here is a summary:

The S&P 500 reached our Bear Case (2400) late last year as we believe it embraced our earnings recession call. We expect upcoming negative data will prove 2600-2650 to be a good sale before a proper retest of the December lows. Wait for the retest and look to buy the cyclicals.

We always expected the S&P 500 to visit the low end of our consolidation range (2400-3000); however, we thought it would be in 1Q2019, not at the end of 2018.

While there was a confluence of technical factors that conspired to
create one of the worst Decembers in history, we also think the market
embraced our earnings recession call as earnings revision breadth rolled over. In short, the market is discounting our out of consensus views on growth and it may have even discounted a modest economic recession.

Could our earnings recession turn into an economic one?

Risks are rising, and we don’t have a crystal ball, but we also don’t really care about such an outcome if it’s already priced. A few metrics we like to look at—y/y change in the S&P 500, PMIs, market implied pace of rate hikes (MSP0KE Index), front-end of the yield curve, and the Fed’s recession probability models—have all signaled elevated risk of an economic recession. From an equity perspective, we think a retest of the December lows driven by more earnings and economic data disappointments
would seal the deal on our earnings recession call. We are equity strategists, not economists, and we’ve said all along that an earnings recession amounts to the same thing as an economic one for investors.

Momentum: Defensive skew sending same message as the index

The long side of 3, 6, and 12-month momentum is very crowded in Defensives, while the short side skews heavily toward Cyclicals. The situation is especially concerning in short- and medium-term momentum strategies where nearly a fifth of the long side is in Staples, while nearly a third of the short side is in Energy. This is simply another example of the market anticipating the slowdown. Therefore, we want to buy cyclicals if the market retests the December lows when cries for recession are likely to be loud and irrelevant.

We are seeing early signs that our margin thesis is playing out.

2019 EBIT margin estimates have contracted by ~50 basis points since the beginning of October 2018. This is the most significant negative revision during this period (beginning Oct.-beginning Jan.) since the financial crisis. Both sales growth and earnings growth estimates for 2019 have also come down materially in conjunction with this margin estimate de-rate. We expect margin pressure to be a pervasive theme throughout 2019.