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Morgan Stanley Warns “Market Ripe For A Drawdown” As “Risk/Reward Has Deteriorated Materially”

Morgan Stanley Warns "Market Ripe For A Drawdown" As "Risk/Reward Has Deteriorated Materially"

For much of November and early December (recall "Stocks are Overbought And Frothy" Warns Wall Street’s Most Accurate Analyst"), Morgan Stanley’s…

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3 years ago

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Morgan Stanley Warns "Market Ripe For A Drawdown" As "Risk/Reward Has Deteriorated Materially"

For much of November and early December (recall "Stocks are Overbought And Frothy" Warns Wall Street's Most Accurate Analyst"), Morgan Stanley's chief US equity strategist, Michael Wilson, repeatedly warned that stocks are poised for an (at least) 10% correction around year-end, before resuming their bullish trek higher (albeit under a different leadership as growth stocks are shunned in favor of value names). Well, the end of 2020 came and went and stocks pushed ever higher without a second thought, making a mockery of all predictions of imminent corrections.

So now that we are in the new 2021, has Wilson thrown in the towel on his imminent bearishness and has he joined the army of Wall Street strategists who see nothing but smooth sailing ahead?

Not at all: in fact, according to his first US Equity Strategy research note for 2021, the strategist warns that "extreme optimism and/or high valuations" has persisted, and while they are neither necessary nor sufficient conditions for a meaningful equity market correction, he must acknowledge "that the "risk reward" of the US equity market has deteriorated materially and the market is ripe for a drawdown." As potential catalysts for said correction he lists the Georgia Senate seat run-off election, softer guidance than expected during 4Q earnings season, and some kind of intervention by regulators and/or the Fed to quash the exuberance in crypto-currencies, while "exhaustion and positioning will do the rest." To wit:

Unlike humans, financial markets don’t have feelings. Instead, they look ahead and discount what humans often can’t see or even imagine. In fact, 2020 may go down as one of the best examples on record of such vision. In late February, markets quickly discounted the end of the cycle, with many stocks falling 50% or more in a month. Then, just as quickly, markets began to discount what would be the fastest recovery on record. The "risk/reward" of investing is always greatest when fear is highest because valuation is cheapest. 2020 was textbook in that regard with March offering a generational opportunity to buy stocks.

The setup couldn’t be more different today. Optimism is high because the recovery is now visible to all and prices have appropriated adjusted. The only fear now is about missing out.

And while Wilson concedes that "extreme optimism and/or high valuations are necessary but insufficient conditions for a meaningful equity market correction" he acknowledges "that the "risk reward" of the US equity market has deteriorated materially and the market is ripe for a drawdown. Potential catalysts could include the Georgia Senate seat run-off election, softer guidance than expected during 4Q earnings season, and some kind of intervention by regulators and/or the Fed to quash the exuberance in crypto-currencies. Exhaustion and positioning will do the rest."

But wait, there's more.

Reminding clients that one year ago he suggested that a recession was likely to arrive in the next 12 months because the end-of-cycle conditions were vulnerable to a shock, the actual outcome - and one which Morgan Stanley did not expect - was a global pandemic which served as the shock in question, "but the public health nature of it almost ensured a more aggressive transition to fiscal policy than even what we had been expecting."

Taking this a step further, Wilson writes that "one could argue we have officially moved into what was first described by Nobel winning economist Milton Friedman in 1969 and subsequently by former Federal Reserve Chair Ben Bernanke in 2002 as “helicopter money.”

In short, as the MS strategist describes it, the new regime is defined by the Fed using its balance sheet to print money and send it directly to consumers and companies who will spend it in the real economy. This is very different than the Quantitative Easing programs used after the financial crisis, which simply shored up damaged consumer and bank balance sheets.

In other words, the money-printing then was simply filling a hole left by the crisis. This time around, money is creating newfound spending that has led to the fastest economic recovery on record (Exhibit 2).

Taking this another step further, the results of the recent election and the announcement that Janet Yellen will be appointed as Treasury Secretary suggest that we are likely to see more political support for Modern Monetary Theory (MMT) policies and specific programs like Universal Basic Income (UBI). Furthermore, Wilson believes that "the public may demand a QE for the people this time."

Ominously, what this means to the bank which recently surpassed Goldman in total trading revenues "is that the Fed may no longer be in control of the velocity of money and that is exactly the kind of sea change that can lead to unexpected outcomes in the financial markets."

Of course, so far we have only seen the benefits from this nascent explosion in helicopter money, with a surge in asset prices tied to accelerating economic growth (i.e. stocks), especially cyclically oriented equities

Yet while almost all stocks have done well since the market lows in March, 'new leadership is emerging' according to Wilson. This is natural after a recession, particularly one that was triggered by a health crisis and led to a generational shift from monetary to fiscal policy dominance.

These new areas of leadership line up with what we have been recommending and allocating to since March—small caps, consumer discretionary, materials, financials, cyclical tech like semiconductors and hardware and industrial stocks.

Yet while all of the above may explain how we ended up here, what does it mean for the future? Looking ahead, the question for investors should center around the unexpected consequences of this policy change and what it could mean for asset prices going forward, according to Morgan Stanley.

Wilson writes that in his view, "the big surprise of 2021 could be higher inflation than many, including the Fed, expect." And while he notes that currently the consensus is expecting a gradual and orderly increase in prices as the economy continues to recover, the move in asset prices like Bitcoin suggest markets are starting to think this adjustment may not be so gradual or orderly.

Needless to say, Wilson agrees with this troubling outlook, and explains that "with global GDP output already back to pre-pandemic levels and the economy not yet even close to fully reopened, the risk for more acute price spikes is greater than appreciated." He then cautions that that risk is likely to be in areas of the economy where supply may have been destroyed and ill-prepared for what could be a surge in demand later this year—e.g. restaurants, travel and other consumer/business related services. As such, while the best inflation hedges are stocks and commodities in the intermediate term, "inflation can be kryptonite for longer duration bonds" - and stocks - "which would have a short term negative impact on valuations for all stocks should that adjustment happen abruptly."

Finally, as Wilson peruses the financial markets today, he can’t help but notice one major outlier to the constructive economic story line that has now been adopted by most investors: long-term bonds/interest rates: "No other asset in the world is as mispriced for even the modest increase in growth/inflation that is expected. Based on some simple relationships with stocks, commodities and economic growth projections, the 10-year US Treasury yield appears to be at least 100 basis points, or 1%, too low."

According to Wilson, this should be the most crucial consideration for investors because every asset in the world is dependent on the 10-year US Treasury yield. It is the pricing mechanism for all long-duration financial and real assets—equities, credit, real estate and commodities. In other words, while better economic growth positively affects the value of these assets, low long-term Treasury yields play just as big of a role, if not bigger.

Quantifying the impact of such a move, and using the S&P 500 Index as an example, Wilson writes that an increase of 1% in the 10-year US Treasury yield from current levels would lead to an 18% decrease in the price/earnings multiple (P/E), all else equal. For the Nasdaq 100 Index, such a rise would equate to a 22.5% decline in the P/E according to the MS strategist who writes that "while such an abrupt increase in interest rates is unlikely, we wouldn’t rule it out."

The point here is that asset prices are looking rich at the moment given the upside risk to interest rates and very low chance they fall further in the absence of some bad economic developments.

As Wilson concludes, "while there is still very good potential upside for many of the stocks we like in this new bull market, one should be prepared for an adjustment in valuations lower as  interest rates catch up to what other asset markets have been saying for months. If this adjustment is gradual, then stocks and other assets will likely go sideways for a while until earnings eventually take them higher. However, should that adjustment in rates occur more rapidly, all stock prices will adjust lower, perhaps sharply, rather than just go sideways. We suspect such an adjustment is more likely than most if we are right about growth and inflation surprising further on the upside."

To this we would add just one caveat: if stocks indeed plunge, all of the freshly released money will go back into - where else - Treasurys, which will promptly send yields much lower, which will ease any fears of a sharp and violent repricing higher in yields, and so on. In short: while the bearish case is one of a sudden jerk higher in yields and lower in stocks, the reality is that such a move would not be linear but would take place in a staggered staccato as investors bounce from stocks to bonds and back again.

Finally, don't forget the Fed which will immediately implement its plunge protection powers should yields truly surge and force stocks to crash. In fact, some would welcome such a development as an outsized risk asset crash would merely force the Fed to cross the final Rubicon and after it started buying corporate bonds last March, Powell (and Yellen) would finally join the BOJ and SNB in openly "monetizing" stocks in the open market.

Tyler Durden Mon, 01/04/2021 - 13:05

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Key shipping company files for Chapter 11 bankruptcy

The Illinois-based general freight trucking company filed for Chapter 11 bankruptcy to reorganize.

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2 hours ago

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March 14, 2024

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The U.S. trucking industry has had a difficult beginning of the year for 2024 with several logistics companies filing for bankruptcy to seek either a Chapter 7 liquidation or Chapter 11 reorganization.

The Covid-19 pandemic caused a lot of supply chain issues for logistics companies and also created a shortage of truck drivers as many left the business for other occupations. Shipping companies, in the meantime, have had extreme difficulty recruiting new drivers for thousands of unfilled jobs.

Related: Tesla rival’s filing reveals Chapter 11 bankruptcy is possible

Freight forwarder company Boateng Logistics joined a growing list of shipping companies that permanently shuttered their businesses as the firm on Feb. 22 filed for Chapter 7 bankruptcy with plans to liquidate.

The Carlsbad, Calif., logistics company filed its petition in the U.S. Bankruptcy Court for the Southern District of California listing assets up to $50,000 and and $1 million to $10 million in liabilities. Court papers said it owed millions of dollars in liabilities to trucking, logistics and factoring companies. The company filed bankruptcy before any creditors could take legal action.

Lawsuits force companies to liquidate in bankruptcy

Lawsuits, however, can force companies to file bankruptcy, which was the case for J.J. & Sons Logistics of Clint, Texas, which on Jan. 22 filed for Chapter 7 liquidation in the U.S. Bankruptcy Court for the Western District of Texas. The company filed bankruptcy four days before the scheduled start of a trial for a wrongful death lawsuit filed by the family of a former company truck driver who had died from drowning in 2016.

California-based logistics company Wise Choice Trans Corp. shut down operations and filed for Chapter 7 liquidation on Jan. 4 in the U.S. Bankruptcy Court for the Northern District of California, listing $1 million to $10 million in assets and liabilities.

The Hayward, Calif., third-party logistics company, founded in 2009, provided final mile, less-than-truckload and full truckload services, as well as warehouse and fulfillment services in the San Francisco Bay Area.

The Chapter 7 filing also implemented an automatic stay against all legal proceedings, as the company listed its involvement in four legal actions that were ongoing or concluded. Court papers reportedly did not list amounts for damages.

In some cases, debtors don't have to take a drastic action, such as a liquidation, and can instead file a Chapter 11 reorganization.

Truck shipping products.

Shutterstock

Nationwide Cargo seeks to reorganize its business

Nationwide Cargo Inc., a general freight trucking company that also hauls fresh produce and meat, filed for Chapter 11 bankruptcy protection in the U.S. Bankruptcy Court for the Northern District of Illinois with plans to reorganize its business.

The East Dundee, Ill., shipping company listed $1 million to $10 million in assets and $10 million to $50 million in liabilities in its petition and said funds will not be available to pay unsecured creditors. The company operates with 183 trucks and 171 drivers, FreightWaves reported.

Nationwide Cargo's three largest secured creditors in the petition were Equify Financial LLC (owed about $3.5 million,) Commercial Credit Group (owed about $1.8 million) and Continental Bank NA (owed about $676,000.)

The shipping company reported gross revenue of about $34 million in 2022 and about $40 million in 2023.  From Jan. 1 until its petition date, the company generated $9.3 million in gross revenue.

Related: Veteran fund manager picks favorite stocks for 2024

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Key shipping company files Chapter 11 bankruptcy

The Illinois-based general freight trucking company filed for Chapter 11 bankruptcy to reorganize.

Published

3 hours ago

on

March 14, 2024

By

The U.S. trucking industry has had a difficult beginning of the year for 2024 with several logistics companies filing for bankruptcy to seek either a Chapter 7 liquidation or Chapter 11 reorganization.

The Covid-19 pandemic caused a lot of supply chain issues for logistics companies and also created a shortage of truck drivers as many left the business for other occupations. Shipping companies, in the meantime, have had extreme difficulty recruiting new drivers for thousands of unfilled jobs.

Related: Tesla rival’s filing reveals Chapter 11 bankruptcy is possible

Freight forwarder company Boateng Logistics joined a growing list of shipping companies that permanently shuttered their businesses as the firm on Feb. 22 filed for Chapter 7 bankruptcy with plans to liquidate.

The Carlsbad, Calif., logistics company filed its petition in the U.S. Bankruptcy Court for the Southern District of California listing assets up to $50,000 and and $1 million to $10 million in liabilities. Court papers said it owed millions of dollars in liabilities to trucking, logistics and factoring companies. The company filed bankruptcy before any creditors could take legal action.

Lawsuits force companies to liquidate in bankruptcy

Lawsuits, however, can force companies to file bankruptcy, which was the case for J.J. & Sons Logistics of Clint, Texas, which on Jan. 22 filed for Chapter 7 liquidation in the U.S. Bankruptcy Court for the Western District of Texas. The company filed bankruptcy four days before the scheduled start of a trial for a wrongful death lawsuit filed by the family of a former company truck driver who had died from drowning in 2016.

California-based logistics company Wise Choice Trans Corp. shut down operations and filed for Chapter 7 liquidation on Jan. 4 in the U.S. Bankruptcy Court for the Northern District of California, listing $1 million to $10 million in assets and liabilities.

The Hayward, Calif., third-party logistics company, founded in 2009, provided final mile, less-than-truckload and full truckload services, as well as warehouse and fulfillment services in the San Francisco Bay Area.

The Chapter 7 filing also implemented an automatic stay against all legal proceedings, as the company listed its involvement in four legal actions that were ongoing or concluded. Court papers reportedly did not list amounts for damages.

In some cases, debtors don't have to take a drastic action, such as a liquidation, and can instead file a Chapter 11 reorganization.

Truck shipping products.

Shutterstock

Nationwide Cargo seeks to reorganize its business

Nationwide Cargo Inc., a general freight trucking company that also hauls fresh produce and meat, filed for Chapter 11 bankruptcy protection in the U.S. Bankruptcy Court for the Northern District of Illinois with plans to reorganize its business.

The East Dundee, Ill., shipping company listed $1 million to $10 million in assets and $10 million to $50 million in liabilities in its petition and said funds will not be available to pay unsecured creditors. The company operates with 183 trucks and 171 drivers, FreightWaves reported.

Nationwide Cargo's three largest secured creditors in the petition were Equify Financial LLC (owed about $3.5 million,) Commercial Credit Group (owed about $1.8 million) and Continental Bank NA (owed about $676,000.)

The shipping company reported gross revenue of about $34 million in 2022 and about $40 million in 2023.  From Jan. 1 until its petition date, the company generated $9.3 million in gross revenue.

Related: Veteran fund manager picks favorite stocks for 2024

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Tight inventory and frustrated buyers challenge agents in Virginia

With inventory a little more than half of what it was pre-pandemic, agents are struggling to find homes for clients in Virginia.

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5 hours ago

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March 14, 2024

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No matter where you are in the state, real estate agents in Virginia are facing low inventory conditions that are creating frustrating scenarios for their buyers.

“I think people are getting used to the interest rates where they are now, but there is just a huge lack of inventory,” said Chelsea Newcomb, a RE/MAX Realty Specialists agent based in Charlottesville. “I have buyers that are looking, but to find a house that you love enough to pay a high price for — and to be at over a 6.5% interest rate — it’s just a little bit harder to find something.”

Newcomb said that interest rates and higher prices, which have risen by more than $100,000 since March 2020, according to data from Altos Research, have caused her clients to be pickier when selecting a home.

“When rates and prices were lower, people were more willing to compromise,” Newcomb said.

Out in Wise, Virginia, near the westernmost tip of the state, RE/MAX Cavaliers agent Brett Tiller and his clients are also struggling to find suitable properties.

“The thing that really stands out, especially compared to two years ago, is the lack of quality listings,” Tiller said. “The slightly more upscale single-family listings for move-up buyers with children looking for their forever home just aren’t coming on the market right now, and demand is still very high.”

Statewide, Virginia had a 90-day average of 8,068 active single-family listings as of March 8, 2024, down from 14,471 single-family listings in early March 2020 at the onset of the COVID-19 pandemic, according to Altos Research. That represents a decrease of 44%.

Virginia-Inventory-Line-Chart-Virginia-90-day-Single-Family

In Newcomb’s base metro area of Charlottesville, there were an average of only 277 active single-family listings during the same recent 90-day period, compared to 892 at the onset of the pandemic. In Wise County, there were only 56 listings.

Due to the demand from move-up buyers in Tiller’s area, the average days on market for homes with a median price of roughly $190,000 was just 17 days as of early March 2024.

“For the right home, which is rare to find right now, we are still seeing multiple offers,” Tiller said. “The demand is the same right now as it was during the heart of the pandemic.”

According to Tiller, the tight inventory has caused homebuyers to spend up to six months searching for their new property, roughly double the time it took prior to the pandemic.

For Matt Salway in the Virginia Beach metro area, the tight inventory conditions are creating a rather hot market.

“Depending on where you are in the area, your listing could have 15 offers in two days,” the agent for Iron Valley Real Estate Hampton Roads | Virginia Beach said. “It has been crazy competition for most of Virginia Beach, and Norfolk is pretty hot too, especially for anything under $400,000.”

According to Altos Research, the Virginia Beach-Norfolk-Newport News housing market had a seven-day average Market Action Index score of 52.44 as of March 14, making it the seventh hottest housing market in the country. Altos considers any Market Action Index score above 30 to be indicative of a seller’s market.

Virginia-Beach-Metro-Area-Market-Action-Index-Line-Chart-Virginia-Beach-Norfolk-Newport-News-VA-NC-90-day-Single-Family

Further up the coastline on the vacation destination of Chincoteague Island, Long & Foster agent Meghan O. Clarkson is also seeing a decent amount of competition despite higher prices and interest rates.

“People are taking their time to actually come see things now instead of buying site unseen, and occasionally we see some seller concessions, but the traffic and the demand is still there; you might just work a little longer with people because we don’t have anything for sale,” Clarkson said.

“I’m busy and constantly have appointments, but the underlying frenzy from the height of the pandemic has gone away, but I think it is because we have just gotten used to it.”

While much of the demand that Clarkson’s market faces is for vacation homes and from retirees looking for a scenic spot to retire, a large portion of the demand in Salway’s market comes from military personnel and civilians working under government contracts.

“We have over a dozen military bases here, plus a bunch of shipyards, so the closer you get to all of those bases, the easier it is to sell a home and the faster the sale happens,” Salway said.

Due to this, Salway said that existing-home inventory typically does not come on the market unless an employment contract ends or the owner is reassigned to a different base, which is currently contributing to the tight inventory situation in his market.

Things are a bit different for Tiller and Newcomb, who are seeing a decent number of buyers from other, more expensive parts of the state.

“One of the crazy things about Louisa and Goochland, which are kind of like suburbs on the western side of Richmond, is that they are growing like crazy,” Newcomb said. “A lot of people are coming in from Northern Virginia because they can work remotely now.”

With a Market Action Index score of 50, it is easy to see why people are leaving the Washington-Arlington-Alexandria market for the Charlottesville market, which has an index score of 41.

In addition, the 90-day average median list price in Charlottesville is $585,000 compared to $729,900 in the D.C. area, which Newcomb said is also luring many Virginia homebuyers to move further south.

Median-Price-D.C.-vs.-Charlottesville-Line-Chart-90-day-Single-Family

“They are very accustomed to higher prices, so they are super impressed with the prices we offer here in the central Virginia area,” Newcomb said.

For local buyers, Newcomb said this means they are frequently being outbid or outpriced.

“A couple who is local to the area and has been here their whole life, they are just now starting to get their mind wrapped around the fact that you can’t get a house for $200,000 anymore,” Newcomb said.

As the year heads closer to spring, triggering the start of the prime homebuying season, agents in Virginia feel optimistic about the market.

“We are seeing seasonal trends like we did up through 2019,” Clarkson said. “The market kind of soft launched around President’s Day and it is still building, but I expect it to pick right back up and be in full swing by Easter like it always used to.”

But while they are confident in demand, questions still remain about whether there will be enough inventory to support even more homebuyers entering the market.

“I have a lot of buyers starting to come off the sidelines, but in my office, I also have a lot of people who are going to list their house in the next two to three weeks now that the weather is starting to break,” Newcomb said. “I think we are going to have a good spring and summer.”

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