Morgan Stanley Gets Downright Apocalyptic

Listening to David Greenlaw and/or Jim Caron as they strike out again, and again, and again, with delusions of economic grandure over US GDP and some historic 2s10s bull steepener which is never, ever coming, one would be left with the impression that Morgan Stanley has inherited the title of most permabullish sell side advisory from Deutsche Bank's economics department. Nothing could be further from the truth. Like any other bank, MS has perfectly hedged its rosy outlook by spoonfeeding its retail clients with the rosy view, while whispering the apocalypse case to its institutional clients (judging by last week's pummeling in MS stock, there is not that many of them left). Below we present the view of MS' equity strategy team under Adam Parker, who gives not only a distribution range for his year end S&P target (1004-1425), but a matrix specifying the probability outcome of either case. Bottom line, "while there is 18% upside to the year-end bull case and 16% downside to the year-end bear case, we assign a higher probability to our bear case than bull case, preventing us from becoming increasingly optimistic." When even Morgan Stanley tells you (or rather the whale clients who are now more than happy to sell into every low volume, retail driven rally) there is little to smile about, it is high time to look for the exits.

From Morgan Stanley:

One way to think about what is priced into the equity market today is to look at a range of forward EPS and price-to-forward earnings multiples (Exhibit 2). Forward earnings data have existed since 1976, and the historical median price-to-forward earnings multiple is 13.6x. If the bottom-up consensus estimate of $114 turns out to be achievable, and the median forward earnings estimate were applied to it, the market would trade at 1550. Our base case is 12x $103.2 in 2012 EPS, or 1238. We have boxed in a variety of scenarios close to what is being implied by today’s price, and what would be implied by our bear and bull cases. While it’s impossible to know for sure what combination of multiple and forward EPS is being digested, we do believe that the market is pricing in something close to 12x $100 dollars today.

We don’t think a recession is fully priced in, as market retrenchment is usually far more substantial in that case, recent jobs data did not imply a recession is imminent, and corporate profitability and estimates remain robust. We think management guidance and sell-side estimates must be reduced to believe a substantial buying opportunity is imminent. Secondly, we have always, and continue to assign a higher probability to the bear case than the bull case, and believe the recent price action increases the probability of the bear case. Poor price action, the S&P downgrade of US sovereign debt, and the exacerbation of recent problems in Europe likely decrease confidence and increase the probability of the bear case (Exhibit 3).

Said another way, while there is 18% upside to the year-end bull case and 16% downside to the year-end bear case, we assign a higher probability to our bear case than bull case, preventing us from becoming increasingly optimistic.