Investing Advice: 3 Risks for the Bull Market

Posted On May 21, 2018 2:24 pm

Today, stocks are enjoying a nice rebound, and continuing their recent recovery after the Trump Administration announced over the weekend that the trade war China is on hold.Today’s investing advice is a word of caution, because these good conditions may not be as solid as they seem.

The latest developments would seem to indicate the disappearance, or least diminishment, of one the main concerns investors had over what could derail the bull market. Despite this, Morgan Stanley analyst Steve Wilson has reiterated his bearish outlook, citing three other risks to equities over the next 12 months.

Zerohedge sums up his points and outlook here:

In Morgan Stanley’s latest Sunday Start note, the bank’s chief equity strategist, who toward the end of 2017 turned decidedly gloomy on the US stock market after being one of its biggest bulls a year earlier, said that at the beginning of 2018 his view was out of consensus: “while we agreed 2018 would be a year of robust earnings growth, we differed by arguing that risk markets would not be rewarded for it. For US equities, we envisioned flat to modest positive returns as multiple contraction offset earnings growth.”

And, to be sure, for a while he looked way off: as Wilson notes, “the strong start to the year made our less sanguine view look premature — or just dead wrong.” Yet things quickly changed after the February volocaust, when US equity valuations corrected materially, in large part due to the forward price/earnings for the S&P 500 falling 12% from its December high, largely thanks to a surge in forecast EPS due to Trump tax reform and a record amount of projected buybacks this yearby some estimates as much as $1 trillion. And while some sectors have seen their P/Es fall by much more, the median sector P/E compression closer to 15%.

As a result of the recent market volatility, Wilson says that his recent conversations with investors are not as contentious as they were in January. In fact, he is now worried that his view is simply the consensus… “perhaps implying that our call is much less likely to prove correct. This is not to say the consensus can’t be right; we note an old adage that the consensus is right 80% of the time. The problem now is that the consensus projects much more modest returns”, Wilson laments.

Which, of course, is bad news for investors, who actually have to do some work to generate returns and “have to rely more on idiosyncratic or tactical investment ideas rather than just being long beta.”

Here, Wilson notes one such idea he has recently been vocal about, namely trading a range in the S&P 500 — between 16-18x forward 12-month earnings, and points out that since January’s highs, the market has successfully tested that 16x floor four separate times. “That floor is rising with earnings estimates, and today it sits at 2625.”

 Related: The Real Reason for Rising Interest Rates

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Steve Smith

Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.

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