Our CIO and Chief U.S. Equity Strategist explains why economic
fluctuations have made it more difficult to project a possible
soft or no landing outcome, and how investors can navigate this
continuing market volatility.
----- Transcript -----
Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan
Stanley’s CIO and Chief U.S. Equity Strategist. Along with my
colleagues bringing you a variety of perspectives, today I'll be
talking about the continued uncertainty in economic data and its
impact on markets.
It's Monday, June 10th at 11:30am in New York.
So let’s get after it.
Over the past few months, the economic growth data has
surprised to the downside with more data releases coming in below
expectations than usual. Meanwhile, inflation surprises have
skewed more to the upside. This is a challenging combination
because it means the Fed can't cut rates yet even though it may
make sense to keep the economic expansion going.
As we have been discussing for months, aggressive fiscal spending
is keeping the headline economy looking good on the surface. The
bad news is that inflation remains too high for the Fed which has
to keep interest rate policy too tight for many economic
participants. Some may disagree with that statement, but we think
it's hard to argue with the yield curve which remains
significantly inverted and a valid indicator of interest rate
policy. When combined with high price levels for
many goods and services, the end result is a crowding out of many
parts of the economy and consumers. From our perspective, this is
most evident in the persistent underperformance of small cap
stocks. In fact, this past week, small cap equities relative
performance fell to new cycle lows.
Even more concerning is that while small caps are showing greater
interest rate sensitivity than large caps, it’s also asymmetric.
While higher rates are an obvious headwind for small caps, we're
skeptical that lower rates offer a comparable benefit. Last week
was a good example of this dynamic when small caps underperformed
early in the week when rates rose and later in the week when
rates fell.
All of this argues for what we have been recommending — in an
uncertain macro world, we think investors should stay up the
quality curve with a barbell of both growth and cyclicals to
participate in both the soft and no landing outcomes. We also
think it makes sense to have some defensive exposure as a hedge
against the above average risk of a recession that still looms.
Given the more negative skew in the economic surprise data as
noted, we think the defensive part of the portfolio should
outweigh cyclicals at this point. We favor staples and utilities
specifically in this regard.
With markets sensitive to unpredictable inflation and labor data,
it's very difficult to have an edge going into these releases,
particularly on the labor front where the data itself has been
subject to significant and ongoing revisions. While many market
participants focus on the non-farm payroll data, these data have
been subject to some of the larger revisions we’ve seen in recent
history. Meanwhile, the household survey has been weaker than the
non-farm payroll data and job openings have fallen persistently
over the last 18 months. These diverging labor dynamics are
classic late cycle phenomena based on our experience. For
investors, it's just another reason to stay up the quality curve
and to avoid positioning for a broadening out to lower quality
areas. In our view, such a broadening is unlikely in any kind of
sustainable way until the Fed cuts meaningfully — and by that we
mean several hundred basis points rather than the one-to-two cuts
that are now priced into the markets for this year.
Thanks for listening. If you enjoy Thoughts on the Market, please
leave us a review wherever you listen and share the podcast with
a friend or colleague today.
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