As the Dow Jones Industrial Average slumps nearly 480 points at its worst moment on Monday, and the CBOE VIX index is roiled to climb above 20 again, demonstrating a new range have experienced a historical lack of volatility in 2017, what in the world is going on with these schizophrenic markets?
When Morgan Stanley Strategist Michael Zezas looks at today’s market’s, he might harken back to lessons learned at the dinner table: eat all your vegetables before you get dessert.
Today he looks at the markets and thinks they are violating this common-sense dictum.
“Investors had it good over the past year,” he wrote in a Sunday note titled “When You Have Your Dessert Before Your Vegetables…”
“It feels less like ‘morning in America,’” he opines about the Ronald Reagan campaign slogan, “than ‘happy hour in America.’”
He has issues with the idea US policy actions have meaningfully extended the market cycle. Rather, he says, “markets have already largely reflected, and are currently pricing in, the benefits they delivered.” As a market recovery moves towards a historic ten-year point, extending past bull markets in the past and coming it at the second-longest winning streak in history.
Markets have priced in success and, when looking at the road ahead, they could be selling on any sign of a threat to that success. Ian Winer, Wedbush Securities Director of Equity Trading, thinks 80% of the sell-off is related to the potential for Democrats to take control of Congress to a meaningful degree this fall. Speaking to CNBC this afternoon, he notes that even with the sell-off in FANG stocks, there would typically be a rotation into other sectors. That isn’t happening.
“There is a lid on this market,” Winer said. “You want to sell rallies.”
Zezas, likewise, sees more volatility ahead “as we work through the other side of the policy agenda.” He looks at the benefits from tax reform and says the scale is clear, but their use is “murky.”
“The nearly 8% move in 2018e EPS following the passage of tax reform aligns with our US equity colleagues’ estimate for full potential earnings benefit for the S&P from tax reform (~7.6%), leading us to believe that estimates are baking in a full flow-through of tax reform,” he says, noting that pricing in perfection can lead to performing under expectations. “But with our finding that 44% of companies plan to reinvest tax savings, it is possible that spending on CapEx and wage growth will prevent a full pass-through, meaning 2018 earnings expectations may be too high.”
Another area where he says markets might have gotten ahead of themselves is with deregulation. Rewriting rules can take years, and thus simplifying regulations might not provide economic benefits until after the next Presidential election.
And what happened to all that talk about fiscal stimulus and infrastructure spending? In practice, it sounds great, but in reality, Zezus isn’t a bull.
“In the near term, we don’t have high hopes for more fiscal expansion from infrastructure, given the limits of the midterm campaign calendar, key issue disagreements within Congress, and our questions about whether the size and incentives of the current proposal would actually increase spending,” he wrote.
There are also “cliffs” that must be navigated in the future. This includes the expiration of full capital expenditure expensing in 2023 as well as the switch to more stringent corporate interest deduction limits in 2022.”
What this will create is “a range-bound market multiple as there are few growth accelerants on the horizon in the near term,” he said, pointing to a silver lining. Active fund managers might find “a better opportunity for alpha” as market dynamics could create more performance differentiation among US corporates.
