Some of the most widely read financial news stories involve projections by Wall Street strategists such as Morgan Stanley’s Michael Wilson, who recently conceded he’d misjudged the direction of U.S. stocks this year. There are investors who dismiss these reports, claiming they are like horoscopes, written in sufficiently vague terms that can always be spun after the fact as being correct. Other investors weigh the dueling reports from different brokerage firms to try to refine their investment strategy. Is either view correct? What is the right way to interpret these reports?
The first point is to separate the reports from the headlines. A strategist has three jobs: (1) find some useful information to communicate to investors, (2) get attention and (3) support the firm’s business. Most strategists I know consider (1) the real job, the one they care about, but without (2) nobody listens and without (3) you don’t keep your job.
Strategists for major global financial institutions have large teams and budgets, and access to a vast amount of information and expertise from firm activities and discussions with big investors, business executives and officials. They are smart and hard-working. They’re selling what economists call a “post-experience” good—something consumers can only evaluate after purchase. That is, investors must decide whether to trust a call today, and only learn later whether the call was sound. Sellers of post-experience goods focus obsessively on reputation—strategists must be right often enough to attract any following.
Even the strongest believers in efficient markets acknowledge that there is value to all this information and analysis. Stocks do have some momentum and valuation matters. Direction is hard to predict, but guessing future volatility is easier. Even simple quantitative rules can identify times when real risk-adjusted returns of stocks are higher or lower than the historical average.
Why does this not translate into active mutual fund managers beating the market? Because even when stocks are less attractive than usual, they’re still the best option for most investors. In poor equity markets, few investments do well. Avoiding equities when they seem overvalued and levering them up when they seem undervalued can easily cost more in fees, taxes and loss of diversification than it gains in successful market timing. Sophisticated hedge funds with low costs and high leverage—and Warren Buffett with his genius—can play these games for profit, but most investors are better off sticking with low-cost, well-diversified index funds through thick and thin.
Therefore, while there’s lots of useful information and opinion in good strategist reports, most of the time they will not lead to dramatic portfolio changes.
Psychologically it’s easier to stick to sensible long-term financial plans if the market seems to exhibit some rationality than if it’s entirely random or mood driven. In that sense, strategist reports are helpful for understanding markets and forming long-term expectations. Even when the team is wrong, and the best of them are wrong a lot, at least you’re relying on a smart, informed opinion—almost certainly a better guess than one you form on your own. The analysis might shift a marginal investment decision one way or the other, but searching them for hidden treasure is a waste of time.
It's important to remember (2) and (3) as you read the reports. The headline of a story, and the dramatic phrases in the report, are all chosen to get attention rather than to communicate useful information. That’s not to say they’re false, just oversimplified and dramatized.
For example, when Morgan Stanley’s Wilson—who gained great credibility by being bearish in 2022, then squandered some of that trust by continuing to be bearish in 2023—announced “we were wrong,” you might think he was retracting some of his earlier opinions and was now bullish. Certainly, that’s what piqued the interest of readers, making the Bloomberg News story on his report among the most read of the day.
But no, he says that the rally that proved his team wrong was driven almost exclusively by valuation. In plain words, he got the poor economic fundamentals right, but foolish investors pushed up stock prices anyway. He still thinks stocks will fall when investors come to their senses and realize he was really right all along. And he says we’re in a rally similar to 2019, meaning a burst of froth to be followed by a crash. If anything, the new report is more pessimistic about stocks than his forecast from the end of 2022.
To be fair to Wilson and his team, there’s a lot more in the report. One error he does admit is he, along with almost everyone else, thought Federal Reserve interest rate hikes would be less effective at reducing inflation and more effective at slowing the economy than they appear to have been. Therefore, he expected more inflation, more hikes and a recession. There’s also an interesting discussion about corporate earnings, drilling down on costs, prices and unit sales growth.
Point (3), Morgan Stanley’s business interest, still matters despite 25 years of regulatory effort to make analysts independent of business considerations. Strategists are biased to be optimistic, and to couch recommendations in terms that do not completely close off any transaction any Morgan Stanley customer might care to make. Wilson can be negative on stocks, but he can’t claim to be certain of an impending cataclysmic crash. The report has to offer some attractive sectors or strategies and have enough qualifications so that any deal Morgan Stanley is pitching doesn’t seem terrible.
When I mentally adjust for that, I find this report to be deeply pessimistic about stocks. It’s hard to imagine any major investment bank strategist being more negative about stocks or offering such thin positives, without getting fired. That doesn’t incline me to dump all my stocks and get short, but I take it as a serious warning from a smart, informed person.
Aaron Brown is a former managing director and head of financial market research at AQR Capital Management. He is author of The Poker Face of Wall Street. He is also an active crypto investor, and has venture capital investments and advisory relations with crypto companies.