The S&P 500 is nearing a bull market. But Morgan Stanley analysts are predicting a 16% earnings drop for S&P 500 companies. Ben Laidler, Global Markets Strategist at eToro, and Tom Essaye, Sevens Report Research Founder and President, give their takes on what lies ahead for the market.
BRAD SMITH: First, we've got to think about the S&P 500's Friday rally, and that inching the index closer to exiting its longest bear market in decades. A robust jobs report and debt ceiling resolution fueled investor optimism, and excitement over AI also helping drive some gains. But Morgan Stanley analysts say the rally will reverse course in the months ahead.
In a note Sunday, analysts led by Andrew Sheets predicting earnings per share will drop 16% this year, a bearish outlook at odds with Wall Street estimates. So let's get back to Ben Laidler, who is eToro global market strategist and Tom Essaye, Sevens Report Research founder and president.
Ben, to you first on this. As you think about the number of calls that have now essentially kicked off our week, whether for the S&P 500 or just looking back at what we've seen so far in the S&P 500 rally attempt to get out of a bear market, where does that sit with you? Do you believe that the forecasts that we're seeing right now have some weight or have some support or substantiated evidence to them as well?
BEN LAIDLER: We remain pretty positive, right? I mean, this has been a massive pain trade for most people this year. The fundamentals have definitively turned less bearish. And when everyone is hugely bearish by some measures, almost the most we've ever seen, that's all you need to drive this double-digit S&P 500 rally we've seen this year and 25% for the NASDAQ.
People wanted to call this recession for the last 18 months. And it just hasn't arrived. And therefore, not only are you not seeing earnings fall, you're actually seeing earnings rise. And that's happening alongside rising valuations, which is being allowed by lower inflation, lower bond yields. So this is really the Goldilocks scenario.
And it's a massive pain trade for the bears. And frankly, I think it continues. I think the fundamentals are decent. I'm very happy to say that I do too agree that growth is probably going to slow from here. But I think markets are just going to look through it, frankly. Because inflation's coming down, the Fed's getting flexibility to cut interest rates back.
I think any sort of slowdown in the economy, slow down in earnings, markets are going to look to the other side. And remember, markets are very long duration, right? The market is not the economy these days, right? It's tech, it's health care, it's defensives, it's things that are much more sensitive to inflation, bond yields, and interest rates than it is to growth in the underlying economy, I would argue.
JULIE HYMAN: Yeah. Although you could say, to your point, the growth in the underlying economy isn't that bad, right? Or not as bad as expected. Guys, I've seen the term melt-up applied to the rally that we have been seeing. Tom, you first on this. What does that mean when people talk about a melt-up? And does it matter that-- what are the implications of that that it's being called that?
TOM ESSAYE: So it's sort of a very official term, of course. Now, it's just a wall to Wall Street slang, essentially, for a market that won't go down even if there are headlines that mean it should. And it basically kind of pulls in skeptical investors. So imagine something sort of melting and it spreads as it keeps going.
And that's what we're seeing, right? For the past six weeks prior to Thursday and Friday, five stocks drove the entire market. It's those five AI mega-cap tech names. On Thursday and Friday, it broadened out. Tech actually relatively underperformed. And that's where you're getting people with this melt-up.
Now it's spreading, now it's going across all the sectors of the market. And to Ben's point, if you're underweight, you got to be waking up today really nervous because this thing has momentum in the near-term, and you're missing it. And so now do we create more chasing? And the answer is probably yes.
JULIE HYMAN: So Ben, do melt-ups last?
BEN LAIDLER: Yeah, absolutely. I know it depends on the fundamentals. And I think the fundamentals are very, very solid. We're not in recession. We're going to have a slowdown. It's probably going to be a modest slowdown. Companies, corporates are getting their profit margins back, top line has been resilient.
I think valuations are well supported in investors hopelessly out of position here. So I think as long as-- it always comes back to the fundamentals. If the fundamentals remain less bad, maybe even sort of firm up stronger from here, I think investors can pretend to be as bearish as they like. But investment managers get paid to manage money not to sit on cash.
BRAD SMITH: Well, as well, Ben, you've written around this too. And I imagine both of you have monitored the AI FOMO in some cases as investors are looking across any type of mention and a record number of mentions from S&P 500 companies in this most recent earnings season. But is the AI move that we've seen attached to fundamentals right now from your perspective, Ben?
BEN LAIDLER: I would say absolutely. So I would say two things. So one, I've been doing this a while, I have never seen a company as large as Nvidia be so flat-footed on a revenue outlook for the current quarter as they just were on AI. That was the moment that AI flipped from being hope to being dollars and cents reality. And I think that's massively significant.
Two, this is a lot more than just AI. Know this is tech cost-cutting. This is investors looking for defensive growth. I like big tech. This is lower bond yields and what that does to potential valuations. God help the market or the tech bears if we see Apple really make a go of their AI VR headset today. That would just be another driver to the tech space. Point being, I think there's a lot of drivers to tech here. I don't think there's only one leg to the stool.
JULIE HYMAN: And we're going to talk about Apple more in just a second. But there's something else I'm watching this morning, guys. And that's a new forecast out for Morgan Stanley. For once, it's not Michael Wilson, the US Strategist, who's making this forecast. It's actually Andrew Sheets over there. And the team there is predicting that S&P 500 earnings per share are going to fall 16% this year. Tom, is that nuts?
TOM ESSAYE: No. It's certainly against the consensus. And we have to take it with a grain of salt. And Morgan Stanley has probably been the most bearish shop on the street for the past multiple years, honestly. It certainly got it right last year, not so much this year. But I haven't read that report, but I'm going to guess here's their thesis.
And it goes to what Ben was saying earlier is that basically, if we see broad-based disinflation-- right now we're seeing it on the cost side of things for companies. What if we see it on the finished goods prices, right? So what if there are price wars? Remember those? They can come back. And actually AutoNation last week kind of hinted at one.
So if you see prices start to drop in the marketplace, good for the consumer, not good for corporate earnings because margins are where they're going to make their money. So I think there is a risk of that. Is it imminent? I don't think so. But could it happen between now and year-end? I mean, yeah, it definitely could.
BRAD SMITH: Yeah. And so in which companies does that does that impact the most in your perspective?
TOM ESSAYE: Well, I think that really, you're sort of cyclical companies would get hit the hardest. because your staple demand is going to be there. But if people can't extract greater margins and we have what I call a falling economic tide, whether it's a modest slowdown or a significant slowdown, we don't know, I think those are the names that'll get hurt the worst.
So really, you've got kind of a fork in the road. On one hand, Thursday and Friday should make you very bullish on cyclicals at least from a technical standpoint. But there's earnings risk here. And if they get hit, then the back half of the year is going to be ugly for them.
JULIE HYMAN: I have a feeling, Ben, you have stuff to say about all of this as well.
BEN LAIDLER: Listen, I've got my head in the sand here. The economy is going to slow. That's going to take a chunk out of earnings. All I'm saying is, we've been calling this for a year and a half, where if we're not expecting a certain amount of this at this point, then what have we been doing?
And I do think there are plenty of ways to defend yourself from that. I think it's health care, it's big tech. It's the defensive bets of the market. I would absolutely be steering clear of the cyclicals, of commodities, of small cap, the ones that are going to suffer if growth rolls over here.
But the fact that it's happening this sort of relatively late in the cycle, if it does happen, I think means the Fed's in a position to respond to that. Again, which is why I think markets are-- some sectors will get hurt more than others. But I think the market overall will just look through to the other side of the Fed cutting interest rates and growth flattening out an earnings recovery.