Podcast Summary: "Where Is the Bottom of the Market?" by Morgan Stanley

Podcast Information:

• Title: Thoughts on the Market
• Host/Author: Morgan Stanley
• Description: Short, thoughtful, and regular takes on recent events in the markets from a variety of perspectives and voices within Morgan Stanley.
• Episode: Where Is the Bottom of the Market?
• Release Date: April 14, 2025

Introduction

In the April 14, 2025 episode of Thoughts on the Market, Morgan Stanley's Chief Investment Officer and Chief U.S. Equity Strategist, Mike Wilson, delves into the recent volatility in the equity markets and explores potential future trajectories. With a focus on dissecting the factors that have influenced market movements over the past month and projecting what investors might anticipate moving forward, Wilson provides a comprehensive analysis rooted in both current trends and historical data.

Market Overview and Recent Volatility

Wilson opens the discussion by highlighting the unprecedented volatility that has characterized the equity markets in the first half of April. He notes:

"[00:00] ... Entering April, we were much more focused on growth risks than inflation risk, given the headwinds from AI Capex, growth deceleration, fiscal slowing, DOGE and immigration enforcement tariffs were the final headwind to face..."

The market sentiment was tilted towards optimism for potential relief, despite low investor confidence regarding the outcomes of upcoming events, referred to as "Liberation Day." However, this optimistic positioning backfired when reciprocal tariffs were announced on April 2, leading to a sharp decline:

"...from that afternoon's highs, S&P 500 futures plunged by 16.5% into Monday morning. Remarkably, no circuit breakers were triggered and markets functioned very well during this extreme stress."

This event underscored the fragile balance between investor expectations and actual market responses, showcasing the market's ability to handle significant shocks without triggering trading halts.

Factors Influencing Market Trends

Growth Risks vs. Inflation Risk

Wilson emphasizes that the primary concern at the start of April was growth risk rather than inflation. The interplay between AI capital expenditures (Capex), slowing economic growth, fiscal tightening, and various tariffs created a complex backdrop for market performance. This shift in focus reflects broader economic challenges that extend beyond traditional inflationary pressures.

Impact of Tariffs

The introduction of reciprocal tariffs on April 2 played a pivotal role in exacerbating market volatility. Wilson explains:

"From that afternoon's highs, S&P 500 futures plunged by 16.5% into Monday morning."

The tariffs not only dampened investor sentiment but also introduced uncertainty regarding international trade dynamics, further straining an already weakening economy.

Private Economy Struggles

Another critical point raised is the persistent weakness in the private sector over the past two years. Despite government interventions and consumer spending, the private economy has struggled to maintain robust growth, adding to the overall economic headwinds.

"...the private economy has been struggling for the better part of two years."

Technical Analysis and Market Behavior

Capitulation Day and Momentum Low

Wilson describes the market's reaction on the Monday following the tariff announcement as a "classic capitulation day," characterized by heavy trading volume and widespread selling across various asset classes, including Treasuries, gold, and defensive stocks.

"In my view, Monday was a classic capitulation day on heavy volume."

He posits that this capitulation represents a momentum low for the ongoing correction that began in December for most stocks and even earlier for many cyclical stocks. This suggests that the market may still have room to decline further before reaching its bottom.

Corrections in Cyclicals and Small Caps

The correction within cyclical stocks and small-cap equities has been particularly pronounced. Wilson attributes this to a "quality trade" dynamic, where larger, more stable companies have outperformed smaller, more volatile counterparts, especially as the Federal Reserve maintains higher interest rates.

"While small caps versus Large caps have been in this distinct downtrend for the past four years. This is the quality trade in a nutshell..."

He notes that the Fed's reluctance to cut rates unless necessary has perpetuated this divide, leading to sustained underperformance in small caps and cyclicals.

Quality Trade and Interest Rates

The emphasis on quality in equity investments has been a significant theme. Higher interest rates have disproportionately impacted growth-oriented and smaller companies, which are more sensitive to borrowing costs and economic slowdowns.

"...the Fed maintaining interest rates higher than the weaker cohorts of the economy need to recover. Therefore, until interest rates come down, this bifurcated economy and equity markets are likely to persist."

Future Outlook and Predictions

Potential for Lower Lows

Wilson anticipates that the S&P 500 and other major indices may retest or even break their recent lows as the correction continues. He suggests that the market's downward momentum is likely to persist into the next month or throughout the summer, particularly as earnings forecasts are adjusted downward and valuation multiples remain unstable.

"...Monday will likely prove to be the momentum low for this correction... We likely retest or break last week's price lows for the major indices."

Recession Risks

A heightened risk of recession looms large over the market's future. Wilson underscores that the combination of tariffs and existing economic headwinds increases the probability of a recession being factored into market valuations.

"Markets are now contemplating a much higher risk of recession than normal, with tariffs acting as another blow to an economy that was already weakening from the numerous headwinds."

Fed's Policy Stance

The Federal Reserve's current focus on combating inflation leaves little room for easing monetary policy in the near term. This stance is likely to persist unless credit or funding markets face significant instability.

"...the Fed's apprehension to cut rates or provide additional liquidity unless credit or funding markets become unstable... the Fed is likely to err on the side of remaining on hold despite elevated recession risk."

Sector and Industry Performance

Wilson observes that sector and industry performances have mirrored the overall market downturn, with many experiencing drawdowns comparable to those seen in 2022. This widespread decline indicates that the correction is comprehensive and not limited to specific sectors.

"It's a similar performance story at the sector and industry level, with many cohorts experiencing a drawdown equal to 2022."

Investment Strategy Recommendations

Given the current market conditions, Wilson advises investors against selling individual stocks, particularly at this nascent stage of the correction. Instead, he recommends a strategic approach to risk management:

"...focus on adding risk over the next month or two as markets likely retest last week's lows."

This strategy entails cautious positioning to capitalize on further market declines while maintaining a diversified portfolio to mitigate potential losses.

Conclusion

In summary, Mike Wilson provides a detailed examination of the current market landscape, highlighting significant volatility driven by growth risks, tariff impacts, and persistent weaknesses in the private economy. With the Federal Reserve's tight monetary stance and the looming threat of a recession, the market correction appears far from complete. Investors are encouraged to adopt a measured approach, focusing on strategic risk management and preparing for continued market turbulence in the coming months.

Notable Quotes:

• Market Functioning Under Stress:

  "[00:00] ...markets functioned very well during this extreme stress."

• Capitulation Day Description:

  "In my view, Monday was a classic capitulation day on heavy volume."

• Quality Trade Explanation:

  "This is the quality trade in a nutshell, which has worked so well for reasons that we've been citing for years..."

• Fed's Likely Policy Stance:

  "...it appears likely to err on the side of remaining on hold despite elevated recession risk."

• Investment Strategy:

  "...focus on adding risk over the next month or two as markets likely retest last week's lows."

This comprehensive summary encapsulates the key themes and insights presented by Mike Wilson in the "Where Is the Bottom of the Market?" episode of Thoughts on the Market. By addressing the underlying economic factors, market behaviors, and strategic investment recommendations, the summary provides valuable perspectives for both seasoned investors and those new to the financial markets.