Earnings Growth Will Be Better Than Expected, Morgan Stanley's Wilson Says

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00:00I want to pick up on, I think, a core view of yours for 2025, going into 2026, recessions behind us.

00:06I think that's somewhat unique to you and the team at Morgan Stanley. Just build that out for us.

00:10Yeah, I mean, you know, we try to work six months in the future. I think, you know, a year ago,

00:14I think, remember, we had this conversation after the election. You were saying, Mike,

00:16you sound more optimistic, and I've heard you in a while. And it was kind of, we were thinking six

00:20months in advance. We thought the first half would be tough as they transition from the kind

00:24of growth negative policies to these growth positive policies. All this capex you're talking

00:28about is right in line with the big, beautiful bill. I mean, they're trying to basically reduce

00:32consumption, increase investment. It's a totally different economy. And what that is, it's a

00:37higher velocity economy for all the companies that haven't been doing well for the last, I would say,

00:42three years. We've been sort of in a recession. I would argue strongly. We've done the work on this,

00:46and you know, we've done the analysis with respect to the rolling recession that has been in place

00:50for, I would say, three years. Most of the private economy kind of suffering, government kind of

00:54carrying the water. And then we basically saw all of that come to fruition at the end in April.

00:59April, capitulation day, as I call it, was basically the government recession. That was the final piece

01:04of the rolling recession. And if you actually look at the challenger job cuts, and you look at the

01:09revision data now on the payroll data, it looks to me like a rate of change low, okay, in payrolls,

01:16and a rate of change high in challenger job cuts came in April. So the market's figured all this out.

01:20That's why revision breadth has gone straight up. So rolling recovery, where are we in those stages?

01:25So we deemed it the rolling recovery in April, and we're now seeing that, like these areas of

01:30the market, not everything's going to recover at once, because it's an unorthodox recession. It's

01:34not like everything flushed at once and everything recovers at once. So it is going to be staged.

01:38And we've seen that in the market. We're still narrow, quite frankly. AI, CapEx, is kind of one of the

01:43early recoveries here, semiconductors being an early cycle group. But we're not seeing the other

01:48quote-unquote early cycle groups recover the way they typically do in a new economic cycle. Why?

01:54Because the Fed is behind the curve. The Fed is way behind the curve on rates. They need rates much

01:58lower. If you really want to get the private economy moving, rates are too high. Much lower. How much

02:03lower do you think that really is required to get that broadening out? Well, let's just start with

02:06the two-year treasury yield, okay? So my barometer is always the Fed is behind the curve if Fed funds is

02:13above two-year treasury yields. And in order to stimulate the private economy, I would say they

02:17need to be well below that. So that's 50 basis points just to get to neutral and maybe another

02:21hundred plus to get to something that's more stimulative for the average company and the

02:25average consumer. Are you right now betting on that broadening out and expecting maybe AI to

02:31underperform going forward as they invest more in some of these debt sales and the infrastructure side

02:38and the rest of the economy plays catch-up? Absolutely. Think about the trickle-down effect

02:42of this capital spending. I mean, it's not just going to be semiconductor companies. There's a lot

02:47of infrastructure. There's a lot of job creation. There's a lot of velocity in the real economy.

02:50And the lending channel starts getting going, perhaps for small, medium businesses. That job

02:54creation. Deregulation is another part of that story. Okay, so absolutely, that's what should happen

02:59if things play out the way they could. Now, there's risk to that. Let's say the Fed continues to say,

03:04hey, we still think there's inflation risk. We don't like the inflation rate of 3%. We're not

03:09going to raise our targets there. And then we just kind of drag their feet. It's going to stay

03:13narrow then. It's going to stay up the quality curve. And that's where we are right now, Lisa,

03:17is that people basically are trying to choose between those two outcomes. And I would say right

03:22now, most of the institutional community is still huddled into the high-quality stocks. They

03:25haven't really made the transition yet. Have you? Well, we have in some of our guidance. Yeah,

03:30absolutely. In order for that transition to work, the Fed has to cut, though. That's right.

03:34That's what it's contingent on. It's one of the main things. Now,

03:36dereg is a big part of that. Okay? The capital spending is a part of that. Those can happen

03:40without the Fed cutting significantly. But it would really solidify it for me. And if you go

03:45back and look at all these different economic cycles, small caps and lower-quality stocks

03:50typically don't outperform until the Fed gets below two-year treasury yields. We've documented this.

03:55So, by the way, it doesn't mean these stocks can't work in absolute terms. It just means that

03:59relative outperformance you typically get in that early cycle rotation needs Fed funds to be much

04:04lower. If you look at the Fed next year, are you just expecting a Federal Reserve that's markedly

04:09different than it is today? Well, I think they're being patient here. They're doing their job. I'm not

04:15one to sit here and criticize the Fed left and right. What I see is just a very weird economic cycle.

04:21And I think we've solved the puzzle a little bit on this. And that's why I feel fairly confident that

04:26our narrative we laid out this year has played out now. I'm getting evidence in the marketplace.

04:31I feel more confident in that narrative. And that's sort of the difference. I just think

04:34they're not there yet. They're not where I am in my head. I could be wrong, but I'm pretty

04:38confident about that outcome. Can we finish on big tech? Sure. These companies are changing.

04:42We're used to companies that weren't investing tons. Ultimately, they were giving it back to

04:46shareholders. Now we've seen a subtle twist, I think, from the likes of, say, Meta, who are spending

04:51tons and tons and tons and then coming to the debt market to fund it. That's not what we're

04:55used to with these names. Typically, they're asset-like, capital return heavy. Are you noticing

05:00the same change? And how should we treat those companies differently, if at all, because of

05:04that? So let's talk about the risks for the bull market. We think a bull market started in April,

05:07new economic earning cycle. OK, there are two risks. One is that the Fed drags their feet,

05:12liquidity, funding market stresses kind of pop up. The second one is what you just talked about,

05:17is that the market starts to push back on the fact that free cash flow growth is actually

05:21decelerating for some of these businesses. And the asset-like story is being called into

05:26question. We haven't seen it yet. Although last week was the first time we saw pretty

05:29divergent performance between some of these. And that's a risk. Because if all of a sudden

05:34the market starts to become a governing factor on those stocks, I can guarantee you that the

05:39management teams are going to say, well, maybe we aren't going to spend quite as much. Just

05:42like we saw in the fall of 2024, as we talked about that deceleration in CapEx. And also,

05:46we saw that with other times when these companies spend much money. The market is a governing factor.

05:52The management changed their view, how they're guiding on the CapEx. Right now,

05:56they're getting rewarded for more CapEx. The market. Is it welcome news that they're

05:59leaning on the debt market a little bit more, just as this equity market starts to push back?

06:04Well, I think it's a natural evolution. And just to be clear, in all of these build-outs,

06:09whether it's railroads, electricity, the internet itself, we're now into the debt part.

06:14OK, so now they just raised a ton of capital. Well, they're not going to sit, they're going

06:18to spend it. So that's another reason to be excited on one hand, because we know that money

06:22is going to get spent. It's not going to sit there and collect dust. So typically, it could

06:27last a year, two, three. I don't know. I mean, but it's hard for me to believe that the spending

06:32cycle is over when they just raised gobs and gobs of dollars.

06:34Do you think it jeopardizes capital return programs as these companies take on more leverage?

06:39Yeah, it's competing for the free cash flow. So whether it's CapEx, and by the way, CapEx now

06:42as a percentage of free cash flow is pretty high for these businesses. But once again,

06:46I want to go back. This is by design. The tax bill is basically incenting these companies

06:52to do it now. I mean, the government, the administration is really encouraging businesses

06:57of all types to start investing for the first time in 15 years. We've underinvested in so

07:02many things, not just AI, but like infrastructure and factories and automating production and robotics

07:10and things like that. I mean, this bill is designed to get that engine of growth moving.

07:14And it's happening.

07:15It's happening.

07:15But just putting all these pieces together, this was a core theme, I think a core pillar

07:19for being long U.S. equities for a long, long time. And now it's changed. Is it still good?

07:25I think that's what I'm trying to get out here. Is this still an argument to buy U.S. equities?

07:28I think that the valuation is telling you that the growth is going to be better than we think.

07:32My view is that earnings growth is going to be better next year than people expect.

07:34Now, on the other side of that, I do think we're in a different environment where we

07:39have these hotter but shorter cycles. So we're not in these 10-year economic expansions

07:44anymore. And so it's two years on, one year off. Two years on, one year off. That's what

07:47we've had since COVID, right? 2020, 2021, good. 22, bad. 23, 24, good. 24, 25, not so good.

07:53Now we're into a new two-year cycle. So you just have to understand that because inflation

07:57is right under the surface and now you have a higher velocity economy, that means you're going

08:02to have to trade it a little bit more. But right now, I think we're in a pretty good position.

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