the key themes for 2012 from MS (for full detail see attached report):
- We forecast continued market multiple contraction.
- We believe the 2012 and 2013 analyst estimates are too high.
- Capital Use and Its Consequences Will Matter
Our prediction is that until Bernanke announces $800 billion in LSAPs, most likely split half and half between MBS and USTs, the negative tone out of the banks will not change one bit.
The market has not even opened for regular trading for the first trading day of the year and already predictions for the final print are made. Enter Morgan Stanley, which unlike last year, when it was painfully bullish has come out with an uncharacteristic and quite bearish prediction: « We are establishing a 2012 year-end price target of 1167, representing 7% downside from today’s price. The consensus top-down view has coalesced, with limited variation, around 1350, making our forecast 13% more conservative than the “muddle through” scenario implied by consensus. » And the primary reason for this – a collapse in earnings predictions: « We are launching our 2013 EPS estimate of $103.1, 15% below the bottom-up consensus forecast of $121.1. » Time to reevaluate those record corporate profit margin assumptions? That said, make no mistake – just like SocGen, Goldman, UBS and everyone else, the sole purpose of these bearish forecasts is to get the market to drop low enough to give the Fed cover for QE X. And let’s not forget that Morgan Stanley’s new chief economist is none other than Vince Reinhart, the man who personally recommended selling Treasury puts to get rates lower almost a decade ago. Because as Adam Parker, who made the forecast, knows all too well, if the market indeed closes red for 2012, so will Wall Street bonuses.
First, here is MS’ brief review of 2011:
In retrospect, the resiliency of the US equity market in the face of macro volatility was surprising in 2011. The SPX ending the year essentially unchanged and the Dow ending up 6% in 2011 were better outcomes than we anticipated, with the former slightly above our year-end target of 1238 established on January 3rd of 2011. However, the multiple contracted as we expected, given that SPX earnings appear to have grown roughly 17% in 2011. Multiple contraction remains our core thesis about the US equity market (please see: January 3rd, 2011: Initiating Coverage – The 2011 Playbook, January 10th, 2011: Expanding on Our Contraction Thesis and July 5th, 2011: Could the Multiple Go to 10x?).
This view is consistent with Morgan Stanley chief US Economist Vincent Reinhart’s “After the Fall” paper, which focused on low growth rates post financial crises (C. Reinhart and V. Reinhart, « After the Fall, » FRB Kansas City, Jackson Hole Symposium, August 2010). Underlying the total market performance were some interesting major themes. Quality outperformed junk by nearly 12%, and growth outperformed value by almost 10%, both of which we anticipated (see January 18th, 2011: The Quality / Junk Debate and May 23rd, 2011: Do You Have Style?). Further, mega caps began outperforming in May and outperformed small caps by almost 540 basis points in 2011, something we previewed on March 21st, 2011 (Will Mega and Large Caps Remain an Inferior Asset Class?). We offered specific mega cap stock ideas on May 9th, 2011: A Five-YearView of the $100 Billion Market Cap. Club).
Sector betting was skewed toward the defensive, with utilities, health care, and staples the top 3 performing sectors in 2011 (all of which we overweight). We did not recommend financials, materials, or industrials all year, the three worst performing sectors in 2011 in the GICS ten. Our MOST Strategic Portfolio, a combination of fundamental and quantitative disciplines, outperformed the market by 190 basis points in 2011. For those unfamiliar with the portfolio, please see the back part of this note, which lists current stock picks as well as those deleted during the year.
The portfolio had 60% turnover in 2011 and has an average market capitalization of over $50 billion, in order to enable avid followers to mirror the portfolio composition.
It truly ended up being a flat year. Within the top 500 market capitalization stocks, 246 ended the year down, and 254 up. Winners and losers: Petrohawk Energy (acquired), El Paso (acquired), ISRG, ALXN, and MA were the best five performing S&P stocks in 2011. FSLR, CREE, ANR, ROVI, and NFLX were the five worst performing stocks.
Adjusting for market capitalization (to better show the biggest contributors to a portfolio manager’s performance) changes the list. AAPL, XOM, IBM, PM, PFE, CVX, MCD, WMT, V, and INTC were the biggest 10 contributors, adjusting for size, in 2011. The biggest stocks to avoid included BAC, C, GS, HPQ, and JPM. Making a bet on integrated oil and select technology within mega caps, and avoiding financials, were keys to success.
And now looking at the future:
Our 2012 S&P500 Forecast
The switch of the calendar is more psychological than anything else and doesn’t necessarily mean huge rotations will occur by style, substance, or size. As such, we think some of the major themes we saw in 2011 are still in place today. We prefer mega caps to the broader market, growth over value, and quality to junk.
Our year-end 2012 price target for the S&P500 is 1167, a price implying 7% downside from today’s price by year-end (Exhibit 2). The consensus top-down view for 2012 is 1350, making our outlook 13% more cautious than the consensus top-down call. While top-down expectations are clearly less sanguine for 2012 than they were for 2011 at this time a year ago, there is little variation among the top-down forecasts, implying that a “muddle-through” scenario for the economy and earnings is the consensus. We think the risk-reward is skewed to the negative. Our bear case for the S&P500 is 944, and our bull case 1450. Accounting for the probabilities we see as likely, our expectation for the S&P500 by year-end 2012 is 1167.
We are launching our 2013 EPS estimate of $103.1, 15% below the bottom-up consensus forecast of $121.1.
We made some minor changes to our 2011 and 2012 EPS estimates, modestly raising 2011 from $96 to $97.4, in-line with the consensus forecast. For 2012, we are lowering our estimate from $103 to $100. Less labor productivity and a stronger US dollar are among the key drivers for plateauing profits in our base case. Our 2013 EPS forecast of $103.1 is well below the $121.1 forecasted by bottom-up analysts (Exhibit 3).