Podcast Summary: "Recession Fears Are a Wild Card for Markets"

Title: Recession Fears Are a Wild Card for Markets
Host/Author: Morgan Stanley
Release Date: April 21, 2025
Podcast: Thoughts on the Market

Introduction

In the April 21st episode of Thoughts on the Market, Morgan Stanley's Chief Investment Officer and Chief U.S. Equity Strategist, Mike Wilson, delves into the current state of the U.S. equity market, particularly focusing on the S&P 500's performance and the looming fears of a recession. Wilson provides a comprehensive analysis of the factors influencing the market's stability and offers insights into potential future movements.

S&P 500’s Current Range and Challenges (00:01 - 02:30)

Wilson begins by outlining the S&P 500's recent performance, highlighting its struggle to move beyond the 5,000 to 5,500 range. He attributes this stagnation to a combination of factors limiting both upward and downward movements:

• Upside Constraints:
  • Earnings Revisions: There has been an "acceleration lower in earnings revisions," making it difficult for the index to surpass previous support levels.
  • Tariff Negotiations: Ongoing uncertainties surrounding tariff discussions add to market hesitations.
  • Federal Reserve's Position: The Fed appears to be in a holding pattern, awaiting more clarity on inflationary pressures and the growth impact of tariffs.

Wilson emphasizes, “The Fed appears to be on hold until it has more clarity on the inflationary and growth impacts of tariffs and other factors” (00:45).

Market Sentiment and Stock Ratios (02:31 - 04:50)

Wilson discusses the broader market sentiment, noting that equities have been "contemplating all of these challenges for much longer than the consensus acknowledges." A key indicator he points out is the ratio of cyclical to defensive stocks:

• Cyclical vs. Defensive Stocks Ratio:
  • The ratio peaked a year ago and has since declined by over 40%.
  • This significant drop signals a market that is adjusting its expectations, potentially more pessimistically than previously thought.

He remarks, “The ratio peaked a year ago and is now down more than 40% coming into the year” (03:20), suggesting a deeper market adjustment.

Growth Expectations and AI Capex (04:51 - 07:10)

Wilson presents a less optimistic view on growth, challenging the consensus for the first half of the year. He cites several policy-related factors expected to be growth-negative:

• Policy Sequencing:
  • Immigration enforcement
  • Defense of globalization efforts (DOGE)
  • Tariffs

Additionally, Wilson highlights concerns about AI capital expenditures (capex):

• AI Capex Growth:
  • Anticipated to decelerate, especially in the first half of the year.
  • The Deep Seek announcement in January has heightened investor concerns regarding AI investments.

He notes, “Given the importance of AI capex to the overall growth expectations of the economy, this dynamic remains a major consideration for investors” (06:15).

Market Correction and Future Outlook (07:11 - 10:30)

Wilson argues that the market correction underway is "well advanced both in price and time," having commenced nearly a year ago. The S&P 500 is currently oscillating near the midpoint of the 5,000 to 5,500 range, reflecting uncertainty about future developments.

• Market Volatility:
  • Equities are trading based on future expectations, making predictions increasingly challenging.
  • High volatility is a reflection of this difficulty in forecasting.

Despite the challenges, Wilson offers a cautious optimism:

• Potential Positive Catalysts:
  • Deregulation
  • Lower interest rates
  • AI-driven productivity increases
  • More efficient government operations

He states, “Things like deregulation, lower interest rates, AI productivity and a more efficient government are still on the table as potential future positive catalysts” (08:00).

However, he also warns of the heightened risk of a recession, which "has not been fully priced at the index level in our view." This risk acts as a significant wildcard for the markets.

Earnings Revisions and Sector Performance (10:31 - 13:00)

Analyzing corporate performance, Wilson points out unprecedented levels of uncertainty faced by companies:

• Earnings Revisions Breadth:
  • Revisions are reaching "levels rarely witnessed," approaching downside extremes.
  • This trend supports the view that the current market correction is more advanced than the consensus realizes.

Wilson advises shifting focus toward stocks and sectors that may have already "discounted a mild recession," even if the broader index hasn't fully reflected this adjustment.

Conclusion and Investment Strategy (13:01 - End)

Wilson wraps up by outlining two potential scenarios for the market:

1. Recession Averted:

   • If a recession is avoided, markets might have already hit their lows, with the S&P 500 stabilizing.

2. Recession Confirmed:

   • Should a recession materialize, the S&P 500 could breach below 4,800.
   • Additional bearish factors include potential Fed rate hikes due to tariff-driven inflation or a significant increase in the 10-year Treasury yields beyond 5%.

He summarizes, “We believe recession probability is the wild card now that markets are wrestling with in S and P terms” (12:45).

Investment Recommendations:

• Range Trading: Maintain a position within the 5,000 to 5,500 range until recession risks are clarified by hard data, particularly labor market indicators.

• Quality Focus: Emphasize high-quality equities in portfolios to navigate the current uncertain environment effectively.

Wilson concludes with a reminder to stay informed and adapt strategies based on evolving market conditions.

Notable Quotes:

• “The Fed appears to be on hold until it has more clarity on the inflationary and growth impacts of tariffs and other factors.” (00:45)
• “The ratio peaked a year ago and is now down more than 40% coming into the year.” (03:20)
• “Given the importance of AI capex to the overall growth expectations of the economy, this dynamic remains a major consideration for investors.” (06:15)
• “Things like deregulation, lower interest rates, AI productivity and a more efficient government are still on the table as potential future positive catalysts.” (08:00)
• “We believe recession probability is the wild card now that markets are wrestling with in S and P terms.” (12:45)

This episode provides a nuanced view of the current market dynamics, emphasizing the delicate balance between potential growth catalysts and the looming threat of a recession. Investors are encouraged to remain vigilant, prioritize quality in their portfolios, and stay within the observed market range until clearer economic indicators emerge.