Mike Wilson Sees Semiconductor Stocks Correcting

We begin this hour with stocks adding to gains to kick off the first full week of the first quarter, the third quarter. Mike Wilson and Morgan Stanley writing, falling energy prices, peaking tariff inflation, and contained services keep the Fed on hold rather than hiking this year. Lower real rates should support equities and further fuel the broadening trade. I'm pleased to say that Mike joins us around the table for the next hour. He joins us for more. Mike, good morning. Good to see you. Good morning. Let's just start with the stability we're seeing in the rates market and how important that is to set the stage for what you're anticipating in the next few months? Yeah. I mean, I think you were saying it earlier. Was listening to the show. I mean, there's somebody expecting a hike. There's someone expecting a cut, and we're on hold. And this is, I think, what we gotta get used to is that with the new chair probably not giving as much guidance, he's gonna allow the market to kinda figure it out on its own and have these differing different views. We're in that adjustment period now. And we and I think that's one of the reasons why the market's been a little choppy or even correcting in the last month or so is we're getting used to this new regime, which is gonna be higher volatility and potentially the bond market. But over time, I think what what's gonna end up happening is the market's gonna settle down. It's gonna it's actually more ex more estimates or wider dispersion of estimates actually leads to lower volatility in the pricing over time, but we're in that adjustment period. So we think rates are lower ultimately, particularly at the back end. And, oh, by the way, we've we've talked about this on the show many times. New treasury secretary, you know, new Fed chair, this kinda new Fed treasury accord to really anchor the back end. That's what they're focused on. You gotta get the back end down or at least anchored because you have so much debt that you have to basically finance. Do you think in the meantime, we're confusing a reduction in guidance with an increase in hawkishness Yes. Just in the meantime. Yeah. I think that's right. And and and the market's pricing that now. So that's the good news is that we've already had that adjustment, and that adjustment started four months ago. Right? This is why precious metals have traded really poorly. You know, the day that was announced as a nominee, the gold market peaked, and that that was a sign the dollar has been stronger. So once again, the market has really gotten ahead of this. So rates have reset. We've come down from around 4.2% to 4.1. There's a belief this morning at least we've removed the urgency to hike as soon as July, we can put that story to bed. Crews declined massive reset in crude from triple digits down to the sixties on WTI's. Does that open the door within the equity market? And let's talk about the stock market exclusively. Does that open the door to the broadening trade again? Yeah. That's that's our call, basically, is that that was happening at the beginning of the year, then we had Venezuela and then Iran. By the way, the the market priced Iran before the invasion even happened, or the attacks happened because because it once again, it was pretty well signaled. And and so that's when the broadening trade stopped. The the broadening trade literally stopped the day that the attacks happened, and we had the big spike in oil and then the pricing of the Fed to hike rates. Since or I say mid May, which is when we reiterated the broadening call, we had a different view than most. We thought oil prices would come down, and that has allowed now Fed pricing to sort of stabilize, and that has allowed the broadening trade to to to to re to reignite. Small caps have performed nicely. Just had a massive quarter up by more than 20% on the Russell. We've seen the broadening trade. Speak to the performance we've seen in the equal weight on the S and P 500 as well. Let's talk about the max seven, which increasingly was called the lag seven. You got a note out this morning talking about maybe the money going back into the hyperscalers. Just walk us through how you're thinking about what's happened in tech and that divergence between the big spending companies and the beneficiaries of all that spending and the divergence that's what really widened in the last few months. Yeah. I mean, there's a symbiotic relationship between the spenders and the beneficiaries, and typically, they trade sort of in lockstep. And couple things I'll I'll we we've been writing about for the last several months. Number one, CapEx to sales. That particular factor has been straight up since the big beautiful bill was passed. Right? That that basically, the government's incenting businesses to spend money today rather than later. And so that CapEx to sales factor has been driving a lot of stocks higher. That looks like it's peaking now. And by the way, the hyperscaler stock started to trade poorly about a month and a half ago and into this idea. And but that that's not sustainable. You can't have the spender stocks trading poorly and the beneficiary stocks continuing to go straight up. And now what we saw last week, you know, Meta announced that perhaps they're gonna sell some excess capacity, maybe turn into a a provider of of capacity. That is just a reason for these things to take a break. Also, peak rate of change on revision breath. Right? The the memory stacks. Revisions have been spectacular, but there's they can only go so high. So all that's kinda happening at the same time, and I expect the hyperscalers now to stabilize. That's what's going on in the last couple of weeks, and the semiconductor stocks are gonna are gonna correct. That's a good that's a good development. That doesn't mean the CapEx cycle is over, but that ebbing and flowing between the two is a natural kinda governing factor because you can't have this divergence continue. It's unstable. Your words take a break. That's interesting. Some people have called it a narrative shift for the overall trade and maybe a shift in spending too. Why is it one and not the other? Well, we don't know for sure, but we've had three of these already, John. So since Chat GPT was announced in November 22, we've had three of these sort of mini cycles within the broader structural CapEx cycle, which is that the market starts to question, oh, the return on capital isn't good enough to support this kind of CapEx. What happens then? The stocks trade poorly, and then the CEOs of those companies come out and say, well, you know, maybe we won't spend as aggressively, and then it ebbs the other way. And so that's that's the story. That's the dance back and forth. Now there is gonna be a peer there is gonna be a time, we don't know when it's gonna happen yet, where the the CapEx cycle will exhaust itself, and we will have you know, we've talked about this. The the there is gonna be malinvestment here. We don't think that that spending cycle is over because they just started raising the capital in the credit market. So they're gonna spend the capital. Okay? So but we can have these mini cycles within the in the structural bull market of CapEx. As you know, forget the spending that's not yet happened. It's the intentions that matter and a deceleration in CapEx intentions from here. How do you think this market's gonna internalize the prospect of that in the coming months? Well, it's doing it right now. So we talk about it as a peak rate of change or, you know, trough rate of change, second derivative growth, and that's exactly what's going on. There's two things we're focused on. Earnings revision breadth for the semiconductor stocks themselves are, like, 75%. That's about as high as it goes. We've documented that. So that's gonna roll over. It doesn't mean it goes negative, but the deceleration on that can cause those stocks to correct. And then, of course, the hyperscalers will benefit if the market perceives these companies as being somewhat CapEx disciplined, that they're not gonna do willy nilly spending in a way where free cash flow, you know, goes to zero or negative. And and by the way, free cash flow expectations for some of those companies are going towards zero. That's why they've underperformed. So it's a stance, like I said, back and forth. And now in the last week and a half, the hyperscaler some of the hyperscaler stocks have started to trade better. That's a good sign that we're gonna have this little correction. This could last, you know, four, six, eight weeks, something like that, and then we'll probably have the next up cycle for the These are the names that were in bear markets. I'm talking about Meta and Microsoft. Meta had a better week last week. Chips, you keep using this word correct. When I hear that, I'm just thinking, what do you mean by that? How much is the downside? How big is the downside for somebody's chip names? Well, these are high beta stocks. I mean, they can correct thirty, forty percent in a bull market. No. By the way, just look at the two hundred day moving average. That's a that's probably a really good gauge. These stocks are so extended relative to those moving averages. That's how you gotta think about it. Those moving averages exist for a reason. Right? They always return to the moving averages. Does it happen in a violent way, or does it happen kinda gradually over time? We'll have to wait and see. But, yeah, 30% correction in these stocks is, I mean, well within a possibility. In fact, some of them already have corrected their You can have a 30% correction in chips. Just bear with me here. And you can still see the index move up into the right on the S and P 500 even with the massive weighting they have. But we didn't say that. That's what that's what I'm asking. But I mean, that that's part of our call too is that we think this rotation is happening in a down tape. Okay. Unlike the correction we saw in the precious metal stocks in January because they're such a small part of the index. Energy stocks had a big correction after having a great run-in in in January and February. Now the market traded off a little bit because of the war itself. But what I'm what so I agree with what you're saying or your premise or your question, which is since these stocks are such a big part of the index, it's gonna be really hard for the index to make any upward progress until this rotation has sort of happened. This is a summer story for you? Oh, yeah. This I don't I mean, we're not bearish on the year end. We're we're we're still 8,000 plus for year end, and we've had that call for quite a while based on the earnings story. So that earnings story is very much intact. In fact, the fact that we're rotating now to some of these other areas almost confirms the thesis we've had all year, which is this is not just a tech story. That's a great story, but the broadening story is the story that I think people have really underestimated the rolling recession from a year ago, this operating leverage story, which I think is still very underappreciated. Do you think the banks can start working now too? Well, they have been. I mean, the the the the the money center banks and the capital markets banks really have been Your stock. Absolutely. Goldman stocks, fantastic. I'm talking about the others. The regionals. And so they've started to perform, and that's been an area we've been highlighting. Now the yield curve is flattening still or, you know, is having trouble kinda re steepening. So I think that group could pause a bit. We took that off of our list of favorites for the for the broadening trade this week. But, ultimately, between now and year end, we think we do think the banks are gonna do quite well because this is a strategy of the treasury and the Fed as they want more lending going through the traditional lending sector. So while the euro curve is flattening, loan growth is accelerating, and that's feeding this whole broadening out story of the economy. Right? This is a strategy of the administration. They want a a privately driven organic economic expansion, and that's what we're getting. Notwithstanding that maybe the labor market isn't as robust as some people were hoping, but that's also then feeding the earnings story. Right? Because you're seeing revenue growth without a crazy need to hire a bunch of people, and that's the operating leverage story one zero one. We'll talk about that cost discipline through the hour. Mike Wilson and Morgan Stanley is gonna be sticking with us. Equity futures in this session, highs up by about point 4% this morning on the S and P with an update on stories worldwide.