Several weeks ago, Morgan Stanley’s Adam Parker was comparing rally chasers to cockroaches (not so much due to their outward appearance or intellectual capacity but because of their desire to survive no matter where the next market nuke will blow up). Today, in his Sunday Note, the Morgan Stanley strategist appears to have a mini breakdown while slamming faux “original thinkers” who pretend to be contrarians, while merely perpetuating the status quo, and are “indistinguishable from consensus.” To wit:
Questions need to be asked, fundamentals need to be analyzed, data need to be gathered and compared to historical precedents in order to more accurately predict the patient’s future outcome. Nonetheless, the main questions investors ask us today seem to be about the exterior appearance of the market and not fundamentals. “What is this price action telling you?” “What are other investors asking you about?” “How are other people positioned?” Or, “what’s the current sentiment?” They start by saying “I’m a contrarian investor by nature” and then go on to say the same thing about their view that we have heard in several previous meetings. Romanticizing that you are a contrarian when you are indistinguishable from consensus can’t be good.
They are looking at the price, or external appearance, in making their forecasts and not the fundamentals.
Parker’s rant also touches on some other… nuanced topics, such as fat gluttons buying stocks without reading financial statements, or something like that…
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The Stock Market Doctor, by MS’ Adam Parker
An obese person who doesn’t eat for three weeks can be close to starvation. An extremely skinny person can still be uncomfortably full. Clearly, a doctor assessing these patients solely through a check of external appearances will frequently make the wrong diagnosis and prognosis and prescribe inaccurate treatments. Questions need to be asked, fundamentals need to be analyzed, data need to be gathered and compared to historical precedents in order to more accurately predict the patient’s future outcome.
Nonetheless, the main questions investors ask us today seem to be about the exterior appearance of the market and not fundamentals. “What is this price action telling you?” “What are other investors asking you about?” “How are other people positioned?” Or, “what’s the current sentiment?” They start by saying “I’m a contrarian investor by nature” and then go on to say the same thing about their view that we have heard in several previous meetings. Romanticizing that you are a contrarian when you are indistinguishable from consensus can’t be good.
Our favorite investor question lately has been “when Morgan Stanley’s Prime Brokerage data show net and gross exposures of the hedge fund industry are back to 2-3 year averages, where will the S&P 500 trade?” We are flattered that someone thinks we can compute that, as if isolating a nine-variable problem to one provides us with an accurate answer. We should have answered “2137” or something that seems exact even though it would have been pulled out of thin air. Using the patient analogy, it seems like the stock market doctors are asking the wrong questions. They are looking at the price, or external appearance, in making their forecasts and not the fundamentals.
You know what we haven’t been asked in the last month? What is the growth in earnings implied by today’s price? How has your view of that trajectory changed this year? Which areas of the market may show accelerating growth in cash flows? What is the future value of all cash flows discounted back to the present? How have your assumptions about growth or rates changed recently? In recent weeks, it has been rare to attend an investor meeting that hasn’t been filled with the words “positioning” or “sentiment”. We think investors should stop worrying for a bit about how fat or thin the market appears, and focus on “what it is eating”.
Our view is that the earnings outlook for the S&P 500 for the next two years is pretty similar to what it was when the market was at its lows in mid-February, as we continue to project about 4% per year earnings growth through 2017. Should the recent price action alone alter our view of corporate earnings growth? We think the US consumer is in pretty good shape, with confidence, delinquencies, jobs, housing, and obligations all in reasonable shape.
While earnings didn’t grow year-over-year in 2015 for the market as a whole, they grew nearly 6% excluding the energy sector. We think earnings likely grow this year in healthcare, select technology, consumer discretionary, defense, telecoms, and utilities. The biggest wildcards are financials and energy.
What’s in the price of the S&P 500 right now? The market level today implies a 16x multiple a year from now, on earnings that are 8% higher 2 years from now than today. That is roughly 2050. The multiple on earnings has fattened up a lot in the last two months, but we don’t think the outlook for earnings has really changed very much. When the market rallies for a couple of days and alpha generation has been this poor, the chase always begins. People often eat more when they are drunk. Given the broader context of the “binge” since the February lows, our advice is to be a bit more cautious on meaningful US equity market appreciation from here. The biggest macro investment questions are: 1) Will the China economy slow in the second half of the year? 2) Will the dollar return to a strengthening path? Morgan Stanley’s answers are yes to both, and that supports getting a bit more cautious. The market has fattened up and needs to diet for a few months, not just a couple of days of starvation.
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