Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief U.S. Equity Strategist. Today on the podcast I’ll be discussing how to think about the recent tariff negotiations for equity markets.
It's Monday, May 12th at 11:30am in New York.
So, let’s get after it.
Over the weekend, U.S. China trade negotiations made better than expected progress with both sides agreeing to a détente in the trade war that began just one short month ago. The main question I’m getting from investors is whether they should trust this initial agreement, and if it will eventually lead to something more sustainable? From my perspective, this misses the more important point for equity investors. To remind listeners, equity markets trade in the future.
Therefore, the question to ask yourself is do you think things will be more or less uncertain in six months and will they be better or worse? The other thing to consider is that stocks trade on the second derivative, or rate of change, in growth. On that score, I believe it is likely we saw the trough rate of change in variables that tend to correlate with stock prices the most.
More specifically, earnings revisions breadth showed a meaningful uptick last week for the first time this year. Some of this was driven by a pull forward in demand during the first quarter ahead of the tariff announcements that led to better than feared earnings. In addition, several leading companies posted better than expected results thanks to a weaker dollar. Importantly, the translation benefit for U.S. multinational earnings is likely to be a big earnings tailwind for the next six months.
Many of the growth negative things we were worried about five months ago have played out now with Liberation Day marking the point of maximum negative sentiment and positioning. There is an adage that equity markets bottom on bad news, and I can’t think of a better example of that than Liberation Day last month. Similarly, markets tend to top on good news and this weekend’s better than expected outcome on trade negotiations with China could very well lead to a pause in the rally. Therefore, we would buy dips rather than chase stocks on days like today. Markets can look forward to the possibility of growth positive policy changes that still may be in front of us. Things like tax cut extensions, de-regulation and resolution of the debt ceiling and budget appropriations for the next year.
Finally, with the threat of further escalation of tariff rates now diminished, the Fed can also come back into the picture with rate cuts sooner than perhaps what the Fed told us last week. While we don’t know exactly how much the tariffs will impact inflation over the next year, it is likely to be front-end loaded. In fact, there is a case to be made that tariffs may hurt demand and end up being disinflationary. The Fed is likely to determine this outcome over the summer and could begin to at least signal rate cuts. Such a move will potentially lead to a more sustainable rotation towards lower quality, cyclical stocks and drive animal spirits in a way that many investors were expecting six months ago but simply jumped the gun.
Bottom line, I feel more confident in our original outlook for this year for a tough first half, followed by a strong second one. This outlook was based on our view that AI capex growth was bound to decelerate this year, while policy changes were likely to be growth negative to start. Now, we can look forward to growth positive policy changes and productivity benefits from the spending on AI that has already taken place. After such a strong rally, pullbacks are inevitable but unlikely to be anything like we saw last month. So, buy the dips.
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