A Little-Known Indicator Sees VIX Soaring To 30

While not quite as damning as its 2018 credit forecast, Morgan Stanley’s chief equity strategist Michael Wilson released his 2018 equity outlook this morning, and unlike his last full year forecast which in retrospect was surprisingly accurate, is far more contained, if not outright pessimistic. Wilson himself is quick to remark on just how much conditions have changed over the past 11 months:

At the beginning of the year, we titled our 2017 outlook “Are You Ready for Euphoria” on the basis that 1) Earnings growth was likely to accelerate sharply, 2) Financial conditions would remain very loose as the dollar weakened and long term interest rates remained “pinned” from ECB and BOJ purchases, and 3) Investor sentiment was too bearish about changing global politics and populist anti-trade “rhetoric.” Fast forward to today and we find ourselves close to 180 degrees away from the conditions of 11 months ago. Specifically, we expect S&P 500 earnings growth to peak and financial conditions to tighten over the next 6 months while investor sentiment is no longer bearish with more investors now asking us about our “bull” case rather than our “bear” case and even contemplating the chance for a “melt-up.” As an aside, we can’t help but notice much more aggressive sell side 12 month price targets for the S&P 500 driven mostly by higher valuations – something most were citing as a reason to be bearish last year – even though valuations are 10 percent higher today! In short, we have made a lot of progress toward euphoria although retail inflows to US equities are still absent. We suspect that will change in 2018 if tax cuts are enacted helping us achieve our original 1Q2018 2700 target for the S&P 500.

With that in mind, Wilson notes that while we have yet to see the full-blown Euphoria he called for at the beginning of the year, “we have definitely seen a significant improvement in sentiment, especially from institutional investors and our sell-side strategist peers. The absence of strong and persistent equity flows from retail investors may be the final missing ingredient to conclude this cyclical bull market. We suspect that could happen in early 2018 with the signing of a tax bill.”