We're in the late stages of a bull market, says Morgan Stanley's Andrew Slimmon

Key Concepts

Speculation: Increased focus on potential gains over potential losses, often seen in later stages of a bull market.
Bull Market: A period of generally rising stock prices.
Late Stage Bull Market: The later phase of a bull market, characterized by increased speculation and potential for a market peak.
Money-Losing, Non-Profitable Tech Stocks: Companies that are not currently generating profits but are experiencing significant investor interest.
Fed Cuts (Interest Rate Cuts): Reductions in interest rates by the Federal Reserve, intended to stimulate economic activity.
Fiscal Policy: Government actions related to spending and taxation, which can inject liquidity into the economy.
Liquidity: The availability of money in the financial system.
Bubble: A situation where asset prices rise rapidly and unsustainably, often driven by speculation.
Meme Stocks: Stocks that gain popularity through social media and online communities, often detached from fundamental value.
Price-to-Earnings (PE) Ratio: A valuation metric that compares a company's stock price to its earnings per share.
Future Earnings: Projections of a company's profitability in the future, which is a key driver of stock prices.
Guidance Withdrawal: When a company retracts its previously provided financial forecasts.
Consensus Number: The average forecast for a company's or market's future earnings among financial analysts.
AI (Artificial Intelligence): A sector experiencing significant investor interest and growth.
Concentrated Portfolio: An investment strategy focusing on a small number of high-conviction stocks.
Cash Flow: The net amount of cash and cash equivalents being transferred into and out of a company.

Signs of Increased Speculation in the Market

Andrew Slimman, senior portfolio manager at Morgan Stanley Investment Management, observes that the market is exhibiting signs of increased speculation. This phenomenon is typical in the later stages of a bull market, which began in October 2022 and is now in its fourth year. As the market consistently shows gains, investors tend to shift their focus from managing risk to maximizing profits, thereby introducing a speculative element.

Evidence of Speculation:

Performance of Speculative Stocks: Since the market low in April, the most significant gains have been seen not just in the "Magnificent Seven" (Mag Seven) stocks, but more prominently in speculative, money-losing, non-profitable tech stocks. This trend is identified as a warning sign of a late-stage bull market.

The Debate on Market Stage and Risks

While some analysts believe there is still significant room for the bull market to run, Slimman suggests that the current environment points to a late stage. He draws a parallel to the late 1990s, where the market continued to rise by 100% even in its late stages, indicating that a prolonged late stage is possible.

Key Risks Identified:

Aggressive Fed Cuts: Slimman expresses concern that aggressive interest rate cuts by the Federal Reserve could accelerate the bubble formation.
Fiscal Policy and Liquidity: The injection of liquidity through fiscal policy, combined with potential Fed cuts, could inflate the bubble more rapidly. Slimman believes that if the Fed were to delay or moderate rate cuts, it could extend the duration of the bull market.
Excess Liquidity: He argues that too much liquidity can inflate the bubble faster, leading to a situation where money is "sloshing around," which is a cause for concern.
Meme Stocks: The resurgence of meme stocks is seen as a potential component of this speculative environment, reminiscent of the 2021 surge and subsequent sharp decline following a shift in Fed policy.

Market Valuation and Earnings Reality

A seemingly contradictory point is Slimman's view that the market is not as expensive as some suggest. He explains this by highlighting a common investor error: focusing on current valuations without adequately considering future earnings.

Explanation of Valuation Discrepancy:

Focus on Future Earnings: The stock market is driven by expectations of future earnings.
Accuracy of Earnings Predictions: The accuracy of the denominator (earnings) in the Price-to-Earnings (PE) ratio is crucial.
Company Guidance and Analyst Revisions:
- In Q1, companies beat expectations, but due to uncertainty (e.g., tariffs), they withdrew guidance, leading Wall Street to cut earnings estimates.
- In Q2, earnings were strong, causing Wall Street to play catch-up with real earnings.
Analogy to 2020 COVID: This situation is compared to the initial COVID-19 shock, where companies withdrew guidance, and Wall Street cut estimates, only for actual earnings to be less weak than feared.
Current Earnings Trend: Earnings are currently coming in "excellent," and Wall Street analysts are consistently revising their consensus numbers for the next year upwards since July. This suggests that earnings are outperforming expectations, making the market appear less expensive on a forward-looking basis.

Investment Strategy: Against Betting Against the Market

Despite the signs of speculation, Slimman strongly advises against betting against the current market. He acknowledges that headlines about an "AI bubble" are attention-grabbing but argues that for investors seeking to profit, it's not advisable to go against major companies.

Key Investment Advice:

Do Not Bet Against the Market: "100% not."
Focus on Companies with High Demand: Listen to what large companies are saying; if they "can't keep up with demand," that's where investors should focus.
Concentrated Investment in "Big Guys": Instead of broadening out to an S&P 500 equal-weighted approach, Slimman suggests a concentrated strategy focusing on the "big guys" that are experiencing strong demand.
Risk and Reward in Growth Strategies:
- Higher Risk: Investing in companies taking on debt to grow can yield higher returns but carries greater risk and a potentially less favorable ending.
- Lower Risk (but still growth-oriented): Many companies are using their cash flow to fuel growth and meet demand. The key is to listen to their statements about their inability to meet demand.

Conclusion and Main Takeaways

The market is exhibiting characteristics of a late-stage bull run, marked by increased speculation, particularly in money-losing tech stocks. While risks like aggressive Fed cuts and excessive liquidity exist, the underlying earnings growth is strong and appears to be outpacing analyst expectations, making the market less expensive than it might seem on the surface. Slimman's primary recommendation is to avoid shorting the market and instead focus on investing in large, established companies that are demonstrably unable to meet current demand, suggesting a concentrated approach to capitalize on this trend.