Investors have pushed stocks into the death zone, warns Mike Wilson of Morgan Stanley.

What metaphor best describes the stock market, which has lifted the S&P 500 16% from its October lows and 6% this year?

Morgan Stanley strategist Mike Wilson turned to Jon Krakauer’s best-selling book Into Thin Air, which chronicles the deaths of 12 climbers attempting to summit Mount Everest. The book delves into the death zone, which begins at 3,000 feet from the top of the mountain, at an altitude where oxygen pressure is insufficient to sustain life for an extended period.

“Either by choice or out of necessity, investors have again followed stock prices to dizzying heights as liquidity (oxygen in bottles) allows them to climb into an area where they know they should not go and that they cannot live. a very long time,” says Wilson. “They climb in pursuit of the highest achievement out of greed, assuming they can descend without catastrophic consequences. But oxygen eventually runs out, and those who ignore the risks get injured.”

Wilson says that when the stock started rallying in October, it was priced much lower, with a price-to-equity ratio of 15 and an equity risk premium of 270 basis points. Equity risk premium is the difference between expected returns and safe Treasury bonds, with a higher number meaning investors are more compensated for their stock investments.

By December, however, “the air began to thin” with P-to-E down to 18 and equity risk premium down to 225 basis points. “In the last few weeks of the year, we lost many climbers who advanced further into the death zone,” he said.

But then 2023 began, and “the surviving climbers decided to make another climb attempt, this time taking an even more dangerous route with the most speculative stocks,” on the misguided premise of a pause in Fed interest rate hikes to follow. cuts later this year.

“Investors began to move faster and more energetically, more confident about the soft landing of the US economy. Since they have reached even higher levels, they are now talking about a “no landing” scenario – whatever that means. These are the tricks the death zone plays with consciousness – a person begins to see and believe in something that does not exist, ”says Wilson.

Morgan Stanley

The no-landing scenario is most closely associated with Torsten Slok, chief economist at Apollo Global Management. It should be noted that Slok says that a no-landing scenario where the economy does not slow down is not good for the markets because it would require more aggressive Fed activity to raise rates.

Back to Wilson, who says the P-to-E ratio is now 18.6 and the equity risk premium is 155 basis points, which means “we are in the thinnest air of the entire long-term liquidity bull market.” which started back in 2009. He says the bear market rally that started in October with reasonable prices has turned into a speculative frenzy based on a Fed pause/reverse that won’t come.

Of course, liquidity, largely boosted by Chinese and Japanese central banks, has helped boost global M2 — a measure of the money supply — by $6 trillion since October, he says, “providing the extra oxygen investors need to survive in the death zone” a little longer. .

The US stock market is closed on Monday for Washington’s birthday. Last week, the Dow Jones Industrial Average (DJIA)
+0.39%
and S&P 500 SPX,
-0.28%
fell while Nasdaq Composite COMP,
-0.58%
rose for the sixth time in seven weeks.

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