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00:00The team at Morgan Stanley releasing their outlook for 2026, writing,
00:04we raise our S&P 500 price target to 7,800, driven by strong earnings growth. We believe
00:10that we're in the midst of a new bull market and earnings cycle, especially for many of the
00:15lagging areas. Mike Wilson of Morgan Stanley joins now. Wonderful to see you, Mike. Thanks,
00:20Lisa. So let's start on the optimism. You have been optimistic for quite a while,
00:24talking about the rotation into the adopters, not just the AI tech behemoths. Why are you
00:29getting even more optimistic as the year goes on? Well, I would say it's just a change. It's an
00:34evolving narrative we've had, which is that we think that the policy is still misunderstood,
00:39that they essentially came in this year, did the growth negative stuff first, and now we're looking
00:44at the growth positive stuff. I'm not worried about the economy. What I am a little bit worried
00:48about is that the Fed is kind of dragging its feet. So I would agree with Neil's comment,
00:52the Fed needs to cut, but not to save the economy, but to see the full rotation into these lagging
00:57parts of the market, the interest rate sensitive parts of the market, which is really our story for
01:012028 or 2026. We think that 7800 is dependent on the earnings cycle broadening out. So there's a lot
01:07to unpack there. I want to start with you agreeing with Neil, because Neil had a pretty negative
01:11assessment of the overall economy saying he suspects the trains already left the station with respect to
01:16the pain from the Fed keeping rates where they are for as long as they have, and that we could be
01:21looking at a recession. You seem to disagree on that. So where's the nuance here? What's the difference
01:26between preventing recession and really allowing the rotation into some of these other names?
01:33Yeah. I mean, I think our view has been differentiated that we think we have had a
01:36recession. We went through a rolling recession in the private economy. So I would agree with Neil
01:41that the economy is weak, but it's rebalancing now towards the private economy. I mean, many parts of
01:46the economy have been suffering. Housing, all the interest rates, durable goods, consumer goods,
01:51which have been under pressure, commodity sectors, transportation. There's been no volume
01:55going through the economy, no velocity in the real economy. And the way that the administration is
02:00changing the policy, in addition to the Fed now cutting hopefully next year, you'll see the private
02:07economy now doing much better. The government no longer crowding out these areas that have been
02:11under pressure. But we do need to get that trend that the Fed needs to do more. The Fed needs to cut
02:16rates and they need to probably provide some balance sheet.
02:18I'd say one of the things that Neil talked about was his fear that even if they cut in December,
02:22they're not going to lay out a path for continuous cuts. And Fed Governor Waller seemingly enforcing
02:28that, speaking on Fox moments ago, saying you might see more of a meeting by meeting approach
02:32once you get to January. If you do get that posturing from the Fed that maybe they cut in December,
02:38but it's a meeting by meeting approach, they're not necessarily going to cut in every single one.
02:42Is that enough to allow for that rotation or do you need a clear path of cuts to get it?
02:47No, we need the latter. And I think we're going to get there one of two ways. Either the data,
02:50the labor data is going to basically support our view or my view that we had a rate of change
02:55trough in the labor markets in April. And so that data then will allow the Fed to cut more or signal
03:00they're going to cut more. The second one is that we get more financial stress. That's what's been
03:05going on. We think the market, we wrote about this back in September, early October. We thought the market
03:09was going to have a 10% to 15% correction because the liquidity wasn't there, that the balance sheet
03:14was tightening. And we think there's evidence that that correction is well advanced. All the momentum
03:19stocks, crypto obviously is the topic of the day, down 30% for Bitcoin. I mean, these things are
03:24telling you that the market is worried about this liquidity. So as usual, the markets will dictate
03:30the Fed's timing. So if the market really wants, and look, markets are like children, right? They'll
03:35have a little temper tantrum and then the Fed will respond to that. So is this like a mini 2018 in
03:40that regard, right? You kind of go into end of the year and then there's stress in some of these
03:44financial metrics that the Fed cares about, and then they provide more balance sheets. So we think
03:49there's sort of this tug of war going back and forth, but ultimately it resolves in a more dovish
03:53policy path.
03:54On the point of crypto, a lot was made, I mean, even from Bill Ackman basically saying things that
03:58he thought weren't correlated all of a sudden were that Fannie and Freddie were selling off
04:02because the people who were buying crypto were the same people in those names. Did last week and the
04:06week before this episode, given how much crypto falls, show some vulnerability within the market
04:11structure, within who owns these stocks and how fragile and weak some of those hands are?
04:16I don't think it's showing anything new. I think this has been their whole time, right? I mean,
04:19people waking up to the idea that liquidity is important for the market. I mean,
04:22obviously I don't know what they're doing. I mean, that's kind of crazy, but of course liquidity
04:25matters. I mean, liquidity is, and especially the last 10 years or so, I think that the hard
04:30part about liquidity is it's sort of this sort of nebulous thing. It's hard to measure. And I've
04:35spent a lot, like the last two or three years trying to develop a better skill set around that. And I
04:40think we've got a better handle, but I would say it still is one of these things that's sort of the
04:44invisible hand. And so what you have to do is you have to look at the market to tell you when
04:49liquidity is tight or not. So you kept mentioning the balance sheet. Are you saying QE is going to
04:54start again? Well, they may not call it QE, but yeah, the balance sheet needs to expand,
04:58not only to support financial markets, but to support the better growth that I think is coming
05:02next year, right? So if CapEx really picks up for the first time in 10 years, okay, let's be honest,
05:07we haven't seen much capital spending, but the big, beautiful bill is incenting that. That's a usage
05:12of capital that needs to be supplied by somebody. So the balance sheet needs to grow just to help
05:17the economy and the markets. And so we can call it QE, call it not QE, but generally they need to
05:23expand that. How much is a 7800 target predicated on the idea of the Fed cutting rates and using its
05:28balance sheet to help support liquidity? It's very important. I mean, I would say if we don't get
05:33at least one of those items surprising the markets, meaning more than three cuts, or we get more
05:38balance sheet expansion, call it QE, call it something else, okay, yield curve control, whatever you want
05:42to call it, okay, if we don't get some combination of that, then we're not going to reach our target.
05:46So I'm assuming that we get there either through the labor data or through some financial stress.
05:51So it has been so far that the AI trade has maintained any kind of equity valuation, despite the fact
05:56that people are getting increasingly worried about an economy that you think already has gone through
06:00recession. I just wonder, do you think that ship sailed in terms of AI leadership propping things up?
06:05Do you think that if we don't get the real economy re-accelerating, you cannot get the multiples that we
06:10currently have been seeing on the big tech names? Yeah, I think it's one and the same. I mean,
06:14I mean, obviously the investment in AI is on the premise that it will lead to higher productivity,
06:19adoption, and all that works. I mean, that's the way technology investment works. So you're not going
06:24to have these stocks are not going to work. The leaders aren't going to work if the foundation
06:27itself isn't being supported by the technology investment. We assume that is going to happen in
06:312026. That is part of our thesis. Okay, but it's not without risk. So our job is to lay out our
06:37narrative, which we have conviction in, but then to highlight these risks in the short term or in
06:41the medium term that could throw that narrative off.
06:45Eddie Ardenne also joined us earlier, just saying that some of the air is being taken out of the AI
06:49bubble. And to him, that meant that the melt-up that we've been seeing is going to be harder to
06:54come by. Has something changed, at least with that blind willingness to continue to buy AI-related
06:59stocks, regardless of how much they're spending and what the return on that spend is?
07:03Well, I mean, this is a natural evolution of any capital spending cycle. There's always going to be a
07:06challenge on the return you're going to get. And we've seen this multiple times. We saw it a year
07:11ago. We've talked about this multiple times. In July of 2024, that was the peak in AI-CapEx
07:18deceleration. So this is an ebb and flow. What I like to look at is the AI spenders. How are those
07:23stocks reacting? Is the market enforcing discipline on the AI spenders, which then trickles down into
07:29the CapEx beneficiaries? But we think this is going to happen. The money's been raised now, so the debt
07:35markets are now involved. So that money's not going to sit on these balance sheets. It's going to be spent.
07:40The question is, what's the payoff look like and what's the timing of that payoff? We think we'll see
07:45some of that in 2026, 2027. And so now it's just this transition. You're kind of trading back and forth.
07:50So I want to make it clear. We think there's a broadening out. That doesn't mean that all the AI stuff gets
07:55killed and everything else does really, really well. It can work in harmony. In fact, it needs to work in
08:00harmony to some degree. If you do get a scenario, though, where, let's say, I don't know, Meta,
08:04that seems to be one of the poster children for not getting that return, doesn't get it as much,
08:09and they need to pull back on their spending. But everybody else is still spending. Do you only need
08:13one pillar to fall to really hurt this trade? Or can just any sort of spending happening within
08:18this trade, regardless of who the winner is, continue to lift all the boats? Well, I mean,
08:22look what's been going on, right? So we've seen a massive bifurcation or dispersion in the
08:27performance of not only the hyperscalers, but names within that. To me, that's healthy.
08:31Not everybody's going to win. There's no trophies here. You have to actually win the game.
08:37But all of these companies are competing for the trophy. So in that competition, I think we
08:42continue to see this velocity of spend. And then we're going to see the most exciting part about
08:46this AI spend, to me, is we don't even know yet these new businesses that are going to be created,
08:52these new industries that are going to be created, the efficiencies we're going to get in areas like
08:55health care or education or manufacturing. That's on the come. That's where the real wealth creation
09:01is going to be coming from.
09:02So next year, or maybe the end of this year, when we find out who the next Fed chair is going to be,
09:07how much will that matter to you in terms of whether your bull case will get realized? I mean,
09:11who will necessarily be good for that and who might be a little more problematic for that?
09:16You're probably not going to like my answer, but it doesn't matter to me because ultimately the
09:20market's going to tell the Fed what to do. I mean, that's my general. That's always been my view.
09:24People hate it, but I'm a markets person. The markets dominate. The markets tell investors what
09:28to do. So the markets will kind of force their hand. If the markets believe they need more liquidity,
09:35they will force the Fed's hand. If the market believes it needs more rate cuts, it will force
09:38their hand. Because we've become so financialized at this point. The Fed now is basically obligated to
09:45make sure that we have financial stability to some degree. And they also have an obligation to help
09:49Treasury fund the government. So I don't believe the Fed is independent. I believe they're trying
09:54to work in the best interest of Americans. I'm not saying they're dictated by the White House,
09:58but they are not independent of the markets. They are not independent of the funding requirements
10:02of the U.S. government. So the Treasury and the Fed will work together to do the best they can
10:07to solve those issues.
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