Investors have pushed stocks into the death zone Morgan Stanleys

Investors have pushed stocks into the death zone, Morgan Stanley’s Mike Wilson warns

What’s the best metaphor to describe the stock market, which has sent the S&P 500 up 16% from its October lows and up 6% this year?

Morgan Stanley strategist Mike Wilson has turned to the Jon Krakauer bestseller Into Thin Air, which chronicles the deaths of 12 climbers attempting to scale Mount Everest. The book addresses the death zone, which begins 3,000 feet from the mountain’s summit, an altitude where oxygen pressure is insufficient to sustain life for any length of time.

“Either of their own free will or out of necessity, investors have once again followed share prices to dizzying heights as liquidity (bottled oxygen) allows them to rise to a region where they know they shouldn’t go and not very much can live a long time,” says Wilson. “They climb in search of the ultimate topping out of greed, believing they can descend without catastrophic consequences. But eventually the oxygen runs out and those who ignore the risks get hurt.”

Wilson says when shares started rising in October, they were valued much lower, with a price-to-equity ratio of 15 and an equity risk premium of 270 basis points. The equity risk premium is the difference between the expected earnings yield and the safe-haven government bond yield, with a higher number meaning investors are being compensated more for their equity investments.

However, in December “the air got thinner” with P-to-Es at 18 and the equity risk premium at 225 basis points. “In the last few weeks of the year we lost a lot of climbers who pushed further in the death zone,” he said.

But then 2023 arrived, and “the surviving climbers decided to make another summit attempt, this time down an even more dangerous path, with the most speculative stocks leading the way,” under the flawed premise of a Fed hiatus on interest rates to be followed by cuts later in the year.

“Investors moved faster and with more vigour, and spoke more confidently of a soft landing for the US economy. Since they’ve reached an even higher level, they’re now talking about a “no-landing” scenario – whatever that means. Those are the tricks the death zone plays on the mind — you start seeing things and believing in things that don’t exist,” says Wilson.

The no landing scenario is one most closely associated with Torsten Slok, chief economist at Apollo Global Management. It should be noted that according to Slok, a no-landing scenario – in which the economy does not slow down – is not good for markets as it will require more aggressive rate-hiking activity by the Fed.

Back to Wilson, who says the price-to-earnings ratio is now 18.6 and the equity risk premium is 155 basis points, meaning “we are in the thinnest air of the entire liquidity-driven secular bull market that began in 2009.” He says the bear market rally that started at reasonable prices in October has turned into speculative madness based on a Fed pause/pivot that isn’t coming.

Admittedly, he says, liquidity, which is mostly being sponsored by China’s and Japan’s central banks, has helped boost global M2 — a measure of the money supply — by $6 trillion since October, “assuming investors don’t need extra oxygen to survive a little longer in the kill zone”. .

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