Economic data looks backward while equity markets are looking
ahead. Our CIO and Chief U.S. Equity Strategist Mike Wilson
explains why this delays the Federal Reserve in both cutting and
hiking rates – and why this is a feature of monetary policy, not
a bug.
Read more insights from Morgan Stanley.
----- Transcript -----
Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan
Stanley’s CIO and Chief U.S. Equity Strategist. Today on the
podcast I’ll be discussing why economic data can be
counterintuitive for how stocks trade.
It's Monday, August 4th at 11:30am in New York.
So, let’s get after it.
Since the lows in April, the rally in stocks has been relentless
with no tradable pullbacks. I have been steadfastly bullish since
early May primarily due to the V-shaped recovery in earnings
revisions breadth that began in mid-April. The rebound in
earnings revisions has been a function of the positive
reflexivity from max bearishness on tariffs, the AI capex cycle
bottoming, and the weaker U.S. dollar. Now, cash tax savings from
the One Big Beautiful Bill are an additional benefit to cash flow
which should drive higher capital spending and M&A.
As usual, stocks have traded ahead of the positive sentiment and
the lagging economic data – which leads me to the main point for
today.
Weak labor data last week may worry some investors in the short
term. But ultimately we see that as just another positive
catalyst for stocks. Further deterioration would simply get the
Fed to start cutting rates sooner and more aggressively.
The bond market seems to agree and is now pricing a 90 percent
chance of a Fed cut in September, and the 2-year Treasury yield
is 80 basis points below the fed[eral] funds rate. This spread is
not nearly as severe as last summer when it reached 200 basis
points. However, it will widen further if next month's labor data
is disappointing again.
While weaker economic data could lead to further weakness in
equities, the labor data is arguably the most backward-looking
data series we follow. It’s also why the Fed tends to be late
with rate cuts. Meanwhile, inflation metrics are arguably the
second most backward looking data, which explains why the Fed
also tends to be late in terms of hiking rates. In my view, it's
a feature of monetary policy, not a bug.
Finally, in my opinion, the bond market’s influence is more
important than President Trump's public calls for Powell to cut
rates.
The equity market understands this dynamic, too—which is why it
also gets ahead of the Fed at various stages of the cycle. We
noted in our Mid-Year Outlook that April was a very durable low
for equities that effectively priced a mild recession. To fully
appreciate this view, one must acknowledge that equities were
correcting for the 12 months leading up to April with the average
stock down close to 30 percent at the lows. More importantly, it
also coincided with a major trough in earnings revisions breadth.
In short, Liberation Day marked the end of a significant bear
market that began a year earlier.
Remember, equity markets bottom on bad news and Liberation Day
was the last piece of a long string of bad news that formed the
bottom for earnings revisions breadth that we have been laser
focused on.
To bring it home, economic data is backward looking, earnings
revisions and equity markets are forward looking. April was a
major low for stocks that discounted the weak economic data we
are seeing now. It was also the trough of the rolling recession
that we have been in for the past three years and marked the
beginning of a rolling recovery and a new bull market.
For those who remain skeptical, it’s important to recognize that
the unemployment typically rises for 12 months after the equity
market bottoms in a recession. Once the growth risk is priced,
it’s ultimately a tailwind for margins and stocks, as positive
operating leverage arrives and the Fed cuts significantly.
Based on this morning’s rebound in stocks, it looks like the
equity markets agree.
Thanks for tuning in; I hope you found it informative and useful.
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find Thoughts on the Market worthwhile, tell a friend or
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