From stock price fluctuations to concerns about deflation, the
reactions to the Fed rate cut have been varied. But we still need
to keep an eye on labor data, says Mike Wilson, our CIO and Chief
US Equity Strategist.
----- Transcript -----
Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan
Stanley’s CIO and Chief US Equity Strategist. Along with my
colleagues bringing you a variety of perspectives, today I'll be
talking about the Fed’s 50 basis point rate cut last week, and
the impact on markets.
It's Tuesday, Sept 24th at 11:30am in New York.
So let’s get after it.
As discussed last week, I thought that the best short-term case
for equities was that the Fed could deliver a 50 basis point cut
without prompting growth concerns. Chair Powell was able to
thread the needle in this respect, and equities ultimately
responded favorably.
However, I also believe the labor data will be the most important
factor in terms of how equities trade over the next three to six
months.
On that score, the next round of data will be forthcoming at
the end of next week. In my view, that data will need
to surprise on the upside to keep equity valuations at their
currently elevated level. More specifically, the
unemployment rate will need to decline and the payrolls above
140,000 with no negative revisions to prior months.
Meanwhile, I am also watching several other variables closely to
determine the trajectory of growth. Earnings revision
breadth, the best proxy for company guidance, continues to trend
sideways for the overall S&P 500 and negatively for the
Russell 2000 small cap index. Due to seasonal patterns,
this variable is likely to face negative headwinds over the
next month.
Second, the ISM Purchasing Managers Index has yet to
reaccelerate after almost two years of languishing. And finally,
the Conference Board Leading Economic Indicator and
Employment Trends remain in downward trends; this is typical
of a later cycle environment.
Bottom line, the Fed's larger than expected rate cut can buy more
time for high quality stocks to remain expensive and even help
lower quality cyclical stocks to find some support. The
labor and other data now need to improve in order to justify
these conditions though, through year end.
It's also important to point out that the August budget deficit
came in nearly $90 billion above forecasts, bringing the
year-to-date deficit above $1.8 trillion. We think this fiscal
policy has been positive for growth but has resulted in a
crowding out within the private economy and financial markets.
This is another reason why a recession is the worst-case scenario
even though some argue a recession is better than high price
levels or inflation for 80-90 per cent of Americans. A recession
will undoubtedly bring debt deflation concerns to light, and once
those begin, they are hard to reverse. The Fed understands this
dynamic better than anyone as first illustrated in Ben Bernanke's
famous speech in 2002 entitled “Deflation, Making Sure It Doesn’t
Happen Here.” In that speech, he highlighted the tools the Fed
could use to avoid deflation including coordinated
monetary and fiscal policy.
We note that gold continues to outperform most stocks including
the high-quality S&P 500. Specifically, gold has rallied from
just $300 at the time of Bernanke’s speech in 2002 to $2600
today. The purchasing power of US dollars has fallen much more
than what conventional measures of inflation would suggest.
As a result, gold, high-quality real estate, stocks and other
inflation hedges have done very well. In fact, the newest
fiat currency hedge, crypto, has done the best over the past
decade. Meanwhile, lower quality cyclical assets like
commodities, small cap stocks and commercial real estate
have done poorly in both absolute and relative terms; and
are losing serious value when adjusted for purchasing power.
The bottom line, we expect this to continue in the short term
until something happens to change investors' view about the
sustainability of these policies. In order to reverse these
trends, either organic growth in the private economy needs
to reaccelerate and we’ll see a rotation back to the lower
quality cyclical assets; or recession arrives, and we finish the
cycle and reset all asset prices to levels from which a true
broadening out can occur.
Thanks for listening. If you enjoy the podcast, leave us a review
wherever you listen, and share Thoughts on the Market with a
friend or colleague today.
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