Why the ‘Rolling Recovery’ Has Already Begun cover art

Why the ‘Rolling Recovery’ Has Already Begun

Why the ‘Rolling Recovery’ Has Already Begun

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 Our CIO Mike Wilson joins U.S. Equity strategist Andrew Pauker to answer frequently asked questions about their latest economic outlook, including how U.S. equities are transitioning to a new bull market. Read more insights from Morgan Stanley.----- Transcript ----- Mike Wilson: Welcome to Thoughts on the Market. I'm Mike Wilson. Morgan Stanley’s CIO and Chief U.S. Equity Strategist. Today we're going to try something a little different. I have my colleague, Andrew Pauker from the U.S. Equity Strategy Team here to discuss some of the client questions and feedback to our views. It's Monday, September 22nd at 11:30am in New York. So, let's get after it. Andrew, we constantly deal with client questions on our views. More recently, the questions have been focused on our view that we've transitioned from a rolling recession to a rolling recovery in a new bull market. Secondarily, it's about the tension between the equity market's need for speed and how fast the Fed will actually cut rates. Finally, why is accelerating inflation potentially good for equities? Where do you want to start? Andrew Pauker: Mike, in my conversations with clients, the main debate seems to be around whether the labor cycle and earnings recession are behind us or in front of us. Walk us through our take here and why we think the rolling recession ended with Liberation Day and that we're now transitioning to an early cycle backdrop. Mike Wilson: So, just to kind of level set, you know, we've had this view that – and starting in 2022 with the payback and the COVID demand. And from the pull forward – that began, what we call, a rolling recession. It started with the technology sector and consumer goods, where the demand was most extreme during the lockdowns. And then of course we've had recessions in housing, manufacturing, and other areas in commodities. Transportation. It's been very anemic growth, if any growth at all, as the economy has been sort of languishing. And what's been strong has been AI CapEx, consumer services, and government. And what we noticed in the first quarter, and we actually called for this almost a year ago. We said now what we need is a government recession as part of the finishing move. And in fact, Doge was the catalyst for that. We highlighted that back in January, but we didn't know exactly how many jobs were lost from Doge's efforts in the first quarter. But we got that data recently. And we saw an extreme spike, and it actually sort of finished the rolling recession. Even AI CapEx had a deceleration starting in the summer of 2024. Something else that we've been highlighting and now we're seeing pockets of weakness even in consumer services. So, we feel like the rolling recession has rolled through effectively the entire economy. In addition to the labor data that now is confirming – that we've had a pretty extreme reduction in jobs, and of course the revisions are furthering that. But what we saw in the private sector is also confirming our suspicions that the rolling recession’s over. The number one being earnings revision breath, something we've written about extensively. And we've rarely seen this kind of a V-shaped recovery coming out of Liberation Day, which of course was the final blow to the earnings revisions lower because that made companies very negative and that fed through to earnings revisions. The other things that have happened, of course, is that Doge, you know, did not continue laying people off. And also, we saw the weaker dollar and the AI CapEx cycle bottom in April. And those have also affected kind of a more positive backdrop for earnings growth. And like I said before, this is a very rare occurrence to see this kind of a V-shape recovery and earnings revision breaths. The private economy, in fact, is finally coming out of its earnings recession, which has been in now for three years. Andrew Pauker: And I would just add a couple of other variables as well in terms of evidence that we're seeing the rolling recovery take hold, and that Liberation Day was kind of the punctuation or the culmination of the rolling recession, and we're now transitioning to an early cycle backdrop. So, number one, positive operating leverage is causing our earnings models to inflect sharply higher here. Median stock EPS growth, which had been negative for a lot of the 2022 to 2024 period is now actually turning positive. It's currently positive 6 percent now. The rolling correlation between equity returns and inflation break evens is also now significantly positive. That's classic early cycle. That's something we saw, you know, post COVID, post GFC And then lastly, just in terms of the market internals and kind of what, you know, under the surface, the equity market is telling us. So, the cyclical defensive ratio was down about 50 percent into the April lows. That's now up 50 percent from Liberation Day and is kind of breaking the downtrend that began in April of ...
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