Morgan Stanley is predicting 3-4 percent earnings growth in 2016 and in 2017, said Adam Parker, chief US equity strategist and director of quantitative research at Morgan Stanley.
If investors go out a year from now and pay 16 times for the earnings month 13 to 24, roughly the S&P should be at 2050. The S&P is currently trading 2-3 percent above 16 times earnings, maybe somewhat more optimistic earnings 13-24 months from now.
Morgan Stanley believes the market has come a long way in the rally and the view was more optimistic when the markets were lower in January-February; obviously the risk-reward scenario is getting more balanced now. Investors need to focus on two points macro-wise: One – will the Chinese economy continue to look like it is recovering or will it slow; Morgan Stanley’s answer is it would slow.
Two – will the dollar weaken or continue to be on the longer term strengthening path, and Morgan Stanley thinks it would strengthen. If investors consider those two factors, it could take the air out of some of the risks that was witnessed in the last 2 – 2 ½ months, he explained.
Different analysts have different opinions about the direction of the dollar and some people think the US currency may get into a weakening period and the economic fundamentals are improving. Asked to explain the divergence, Adam said the current sentiment is always trailing the price momentum.
Everyone was worried when the marked popped in February, and the same people are bullish mid-April. It’s all human behavior as everybody is affected by psychology. But Morgan Stanley believes the stimulus in China would ripple through for next two or three months and will ultimately begin to slow.
The old economy sectors like steel, cement, etc. have tremendous excess structural capacity to be worked down over several years. That doesn’t mean there would not be cyclical upturns amid the general down slope, though Morgan Stanley believes that’s more likely.
On the currency front, while it’s tricky to forecast, the general view with Morgan Stanley is that Draghi is more dovish than Yellen and the European economy is likely to be less potent than the US over time.
So, considering those two factors, it’s not all uncorrelated that the markets rally and all the risk-taking seem to be co-incident with the dollar beginning to weaken and China looking better, he explained.
Asked to explain the Federal Reserve’s role in Morgan Stanley’s forecasts, Adam said ultimately everything boils down to rates and growth, and the Fed is going to impact investors’ view about the perception about rates.
It’s really hard to understand in isolation why rates remained so low, but Morgan Stanley believes there could be a rate-hike in December and the current year may look like 2015 when the Fed had to mark-down it’s own economic forecasts and then the kind-of next move was higher.
Morgan Stanley thinks the Fed’s next move is tightening and to the extent it’s later in Europe which may impact the currency call a little bit. Ultimately, if Morgan Stanley’s house call is correct and China slows down a bit from August onward, and the dollar gets a bit back on its strengthening path, all of a sudden people in September-October will say those things are big factors again.
The other thing investors are talking about is the possible UK exit from the European Union – the so-called ‘Brexit;’ maybe people are a little complacent about Europe, which could create a little volatility in June. Morgan Stanley thinks investors are getting to the point where markets rallied a lot, the earnings season is fine, but it may be not enough to power to the next 5-10 percent move higher, he concluded.
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