The phrase is used by mountaineers to describe heights where humans can’t live for long. Survival is said to depend on speed or supplemental oxygen. I recommend just picking hobbies that don’t have death zones. In fact, I’m cautious on most zones: flood, no-fly, hot, impact, euro. I’ll spend time in my comfort zone, but I prefer my happy place.
To learn more about this high-alpine alert for investors, I reached out to its author, Mike Wilson, chief investment officer at Morgan Stanley. He mentioned Into Thin Air, a 1997 book about an ill-fated Everest expedition. Just as oxygen-starved climbers became confused by what they saw, so have liquidity-soaked investors today, he says. The best evidence for that, according to Wilson, is an exceptionally low “equity risk premium.”
The ERP is a mathy representation of something that investors intuitively know: Risky stocks ought to return more than safe bonds. Just how much more is difficult to say with certainty, but by expressing it as a formula, economists can at least argue that the others are doing it wrong. Morgan Stanley puts the S&P 500’s ERP at about 1.6 percentage points, versus more than double that for much of the past decade.
Share prices are up this year. Earnings estimates are down. And Treasuries have gained appeal, thanks to plumped-up yields. Statistically, stocks have passed straight through the high-risk zone into the death zone, Wilson reckons, using his mountain metaphor. The S&P 500 will end the year at 3900, but only after tumbling to a range of 3000 to 3300 during the first half, he predicts. The index was recently spotted around 4000.
We’ve had lower and even negative ERPs, including during the 1990s and early 2000s, when interest rates trended lower amid disinflation. “I think it’s very challenging to feel comfortable saying that in five years, 10-year yields are going to be significantly lower,” says Wilson. “They might be higher. It’s unlikely we’re going back to negative real rates and financial repression and all the things that we did for the past 20 or 30 years.”
Cost growth for U.S. companies has lately outpaced sales growth. The 2023 consensus for earnings underlying the S&P 500 peaked at $250 last May, and has fallen to $222. That’s still 10% to 20% too high, based on a “top down” estimate that uses macro factors like consumer confidence and housing starts, which is faster to respond to major turning points than a “bottom up” consensus of individual company estimates, says Wilson.
Don’t make a panicked call to your stockbroker or to Nepalese air rescue. “We’re not here to try and catch the very low,” says Wilson. “What we’re trying to do is protect people from adding risk at the wrong time, and that’s what people have been doing.” Stock investors should favor defensive sectors like healthcare and consumer staples and efficient operators in industries like retail. Morgan Stanley even has a small Fresh Money Buy List. Names include Coca-Cola (ticker: KO), Exxon Mobil (XOM), and Verizon Communications(VZ).
What about dividends? Intel (INTC) slashed its payout by two-thirds this past week, which would seem to bode poorly for income stocks. But UBS—which, like Morgan Stanley, expects U.S. earnings to fall this year—predicts slight growth in dividends. “If you just plot the chart of dividend growth and earnings growth, dividend growth is much less volatile,” says UBS stock strategist Alastair Pinder. He has found that dividend stocks have tended to outperform by several percentage points during recessions, and that they trade at a 15% to 20% discount to the market now. He also says that payouts look low as a percentage of earnings, and could climb, given a new tax on stock buybacks.
Look for moderate yields with plenty of potential for payment growth, and mix in quality signals like healthy returns on equity, resilient margins, and manageable debt, says Pinder. A recent UBS screen for such companies included Broadcom (AVGO), yielding 3.2%; Amgen (AMGN), 3.6%; Procter & Gamble (PG), 2.6%; and Extra Space Storage(EXR), 4.1%.
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