Mike Wilson on Two Bank Failures Highlight the Consequences of Fed Policy

Impacts of Fed's Policy Tightening

The recent failures of two regional banks have sent shockwaves through the market and sparked renewed bearishness among some investors. Morgan Stanley's Mike Wilson, who had briefly turned bullish, has now purged his newfound optimism and is once again firmly entrenched in the "doom and gloom" camp. In his latest note, Wilson argues that the impacts of the Fed's policy tightening are being felt and that we are already experiencing slowing growth. He expects an "Equity Risk Premium Re-rating," which he believes will lead to significant downside from current levels.

Earnings and Equity Risk Premium

Wilson's view on earnings is "very much out of consensus," although this is not entirely accurate. An earnings recession is, in fact, a widely held belief, but Wilson believes that it will get "properly priced via the Equity Risk Premium." He expects at least a 200bps rise in the ERP from recent lows, which would take the NTM P/E to 13-15x, resulting in significant downside from current levels.

The Collapse of the Two Banks

The collapse of the two banks has highlighted the long and variable lags associated with Fed policy. The pace of Fed tightening over the past year is unprecedented, with the Fed raising the Fed Funds Rate by almost 500bps while engaging in aggressive quantitative tightening. However, the focus on "market-based" measures of financial conditions may have lulled investors and the Fed into thinking that policy tightening had not yet gone far enough, even though more traditional measures like the yield curve had been flashing warnings for the past six months.

Upward Pressure on Cost of Deposits

Wilson points out that banks have been paying well below market rates for the past year because depositors have been slow to realize they can get a much better rate elsewhere. However, this has changed more recently, with depositors deciding to pull their money from traditional banks and putting it into higher-yielding securities like money markets. This trend has put further upward pressure on the cost of deposits, which has been on the rise for months. Wilson expects the Senior Loan Officer Surveys on lending standards to tighten further.

More Small Banks May Fail

The collapse of the two banks should not come as a surprise. For one, the regional banking sector has been struggling for some time. Additionally, the failure of these banks is a natural consequence of the Fed's policies. As interest rates have risen, the cost of borrowing has gone up, making it more difficult for small banks to compete. The recent failures are likely just the beginning, and we may see more small banks going under in the coming months.

What This Means for Investors

So, what does all of this mean for investors? Wilson argues that we are likely in the midst of a bear market rally that will ultimately fade. The end of bear markets is typically punctuated by an event that accelerates the market's pricing of the true downside in earnings. In Wilson's view, that event is happening now, and we should expect significant downside from current levels. However, it is important to remember that markets are unpredictable, and there are many factors that could impact stock prices in the coming months.

In conclusion, the recent failures of two regional banks have sent shockwaves through the market and sparked renewed bearishness among some investors. Morgan Stanley's Mike Wilson, who had briefly turned bullish, has now purged his newfound optimism and is once again firmly entrenched in the "doom and gloom" camp. Wilson argues that we are already experiencing slowing growth and that we should expect an "Equity Risk Premium Re-rating," which he believes will lead to significant downside from current levels. However, it is important to remember that markets are unpredictable, and there are many factors that could impact stock prices in the coming months.