Strategists upgrade their outlook for US and Australian stocks

Morgan Stanley has revised upwards its targets for the US and Australian sharemarkets on the back of a strong end-of-year rally.

A top US equity strategist has ­revised up his 2024 target for the S&P 500 amid a strong year-end rally that is being driven by revival in the “magnificent seven” tech giants.

Morgan Stanley’s chief investment officer and head of US equity strategy, Michael Wilson, also admits to being “too bearish” on US corporate earnings this year even as interest rates soared.

Crucial US CPI data is being released on Wednesday night.

Better US economic data and still above-target inflation has kept the Fed more restrictive than most expected this year, compressing the price-to-earnings multiple of the median stock to 16.5 times, yet the multiple on the capitalisation-weighted S&P 500 remained above 18 times.

The path of earnings growth for the S&P 500 has been “lower directionally” this year, but “we were too bearish in terms of expected magnitude of the decline”, Wilson says.

He attributes this to the “strength of the mega caps” that have “done an outstanding job on cost discipline and taking share in an economy supported by aggressive fiscal spending”.

Whether these heavyweights – Alphabet, Apple, Amazon, Meta, Microsoft, Nvidia and Tesla – can drag the laggards up to their level of performance or if the laggards will eventually overwhelm the leaders’ ability to keep delivering in this challenging macro environment is now a key question.

The October payroll report and inflation report strongly suggest the Fed's last rate rise was in July.

The big debate at the next Fed meeting is shaping up to be over whether and how to modify the postmeeting statement to reflect the obvious: the central bank is on hold.

— Nick Timiraos (@NickTimiraos) November 14, 2023

Wilson says the mega-cap leaders and other high-quality companies have bucked off negative trailing earnings per share growth (despite nominal GDP growth of about 6 per cent) due to cost leadership and superior operational efficiency.

On this score, S&P 500 EPS surprised by 8 per cent in the September quarter, but revenues only surprised by 1 per cent, amid aggressive cost cutting.

But the recent decline in December quarter estimates is “likely an early indication of continued downside for 2024 consensus estimates as companies soon begin to formally guide for next year”.

The S&P 500 came within 5 per cent of Wilson’s year-end target of 3900 points last month, but has soared 7.5 per cent to just over 4400 points since then to be up 15 per cent for the year to date.

As was the case earlier this year, the tech giants have led the market with gains of 10-20 per cent. For December 2024, Wilson forecasts a price-to-earnings multiple of 17 times on a 12-month forward EPS (for 2025) of $US266, which equates to a 4500 target 12 months from now.

His latest forecast for the S&P 500 is 7.1 per cent higher than his target of a week ago.

S&P 500 earnings per share for 2024 is expected to rise 7 per cent versus 2023, to $US229, assuming 4-5 per cent of revenue growth plus modest margin expansion as labour cost pressures ease, while 2025 “represents a strong earnings growth environment”, according to Wilson.

He sees 16 per cent year-on-year growth in S&P 500 earnings per share in 2025 as positive operating leverage and tech-driven productivity growth from the use of AI leads to margin expansion.

Goldman Sachs has made a similar, albeit longer-term call on the impact of AI on US corporate productivity.

Still, Morgan Stanley’s Wilson maintains that the near-term backdrop “remains challenged”.

“Earnings revision breadth, which typically leads consensus estimates, has rolled over once again and is at the lowest level since March this year,” he says.

Underpinning this trend is more cautious corporate commentary overall that’s once again centred on the economy. Leading indicators like the ISM PMIs and the Conference Board Consumer Confidence Index have also taken a recent turn lower amid increasing cyclical and geopolitical risks.

Furthermore, the significant fiscal impulse that helped to fuel the resilience of growth this year is now decelerating in rate-of- change terms, and a “higher for longer” interest rate view is increasingly weighing on both corporate and consumer sentiment.

In his view, the combination of these factors suggests that earnings headwinds will persist into early next year before a durable recovery takes hold.

Meanwhile, the bank’s Australian strategy team has also lifted its 12-month price target for the S&P/ASX 200 to 7350 points versus 7200 previously, implying 10 per cent total return upside.

It comes after Morgan Stanley strategists led by Jonathan Garner upgraded Australia shares to equal weight, from underweight, citing “fairer value and a more balanced risk-reward”, despite concerns about a “final phase of tightening” and economic slowdown.

“The next six months should see fuller effects from the final phase of a monetary hiking cycle affecting domestic-focused earnings,” says Morgan Stanley Australia strategists led by Chris Nicol.

While continuing to see downside risk to domestic industrial earnings, particularly in the first half of 2024, they say the ­impact on industrial earnings should start to “base out”, together with “clarity on the depth and shape of the economic cycle improvement”. They see upside risk for resources linked to higher commodity prices and a weaker exchange rate.

Their model portfolio has been “concentrated” in terms of the number of stocks held and also skews within sectors. Its broad ­positioning bias has overweights in insurance, energy, BHP and Rio Tinto, healthcare and global GARP (growth at a reasonable price) stocks.