Why Morgan Stanley's top strategist thinks a half-point Fed interest-rate cut would actually hurt stocks
By Jamie Chisholm
Critical information for the U.S. trading day
Futures early Monday suggest the U.S. stock market may try to recover somewhat after the S&P 500 SPX dropped 4.25% in the previous four trading days, its worst - albeit holiday-shortened - week since March 2023.
The primary cause of the pullback is in debate. Some observers lay the main blame at fears the Federal Reserve is "behind the curve" as the U.S. economy deteriorates. Others place greater emphasis on the recalibration of AI-linked technology valuations.
Michael Wilson, equity strategist at Morgan Stanley, recognizes that it's a bit of both. In a note published Monday, he says that traders at the end of last week wanted to see that the previous soft jobs report was somewhat of an aberration, helping to justify the S&P 500's rather rich - by historical standards - earnings multiple. They were to be disappointed.
"With index level valuation back up to 21 times into the release, the equity market was looking for a clear signal that last month's payroll weakness was driven by weather and one-off factors. Instead, softness persisted with last month's payroll result revised even lower," says Wilson.
This has meant that the equity market is now "catching down" with the worsening economic fundamentals, according to Wilson.
The question for investors, says Wilson, is whether this relationship will realign from improving jobs data or falling equity prices.
"Our view is that it could be a bit of both assuming a soft landing outcome (our base case). Under a hard landing outcome (our bear case), the reset would come much more from lower equity prices, which is why the market is so sensitive to the labor data at this point in the cycle," he says.
In the current environment of a slowing labor market Wilson reckons that quality and defensive stocks should continue to outperform, though he also notes that what he terms the macro markets of bond yields, foreign exchange and commodities have been showing more concerns about those hard-landing risks.
In particular, the spread between the 2-year Treasury yield BX:TMUBMUSD02Y and the fed funds rate reached has hit around 190 basis points, which matches the widest levels reached in the past 40 years, he observes. "This pricing suggests the bond market believes the Fed is behind the curve from an easing standpoint."
And now Wilson fears the stock market market is increasingly worrying about the same, and has begun questioning whether a 25-basis-point rate cut next week would be an adequate response to the weaker jobs data.
However, Wilson has a warning for those equity investors who may think they would like the Fed to cut rates by 50 basis points on the meeting ending Sept. 18. "A quick drop in U.S. front end rates could cause the yen to strengthen further, thus eliciting an adverse reaction in U.S. risk assets tied to the carry trade unwind," he says.
A revisit to the yen surge and market dive of Aug. 5 would not be good for investor nerves, so perhaps a 25-basis-point cut along with an end to the Fed's quantitative tightening is the best option for the stock market, Wilson implies.
"The bottom line, until the bond market starts to believe the Fed is no longer behind the curve (spread between 2-year yield and Fed Funds narrows), growth data reverses course and improves materially or additional policy stimulus is introduced, it will be difficult forequity markets to trade with a more risk on tone, in our view," says Wilson.
Morgan Stanley reckons volatility will remain elevated in the near term, and with its fair value multiple for the S&P 500 of 19 times that brings the index into a fair value range of 5,000 to 5,400.
Markets
U.S. stock-index futures (ES00) (YM00) (NQ00) are higher as benchmark Treasury yields BX:TMUBMUSD10Y also rise. The dollar index DXY is gaining, while oil prices (CL.1) inch up and gold (GC00) is trading around $2,502 an ounce.
Key asset performance Last 5d 1m YTD 1y S&P 500 5408.42 -4.25% 1.20% 13.39% 21.33% Nasdaq Composite 16,690.83 -5.77% -0.33% 11.19% 21.29% 10-year Treasury 3.758 -15.00 -15.00 -12.29 -53.20 Gold 2525.1 -0.43% 0.47% 21.88% 29.81% Oil 68.4 -7.13% -14.14% -4.11% -21.66% Data: MarketWatch. Treasury yields change expressed in basis points
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The buzz
U.S. economic data due on Monday include wholesale inventories for July at 10 a.m. Eastern time, and August consumer credit at 3 p.m.
Apple (AAPL) will show off its new iPhone 16 model at an event starting 1 p.m. Eastern time.
Oracle (ORCL) will present its earnings after Monday's closing bell.
Shares of Palantir (PLTR) are up 9% in premarket action, and Dell (DELL) is up 5% after the stocks were added to the S&P 500 index after Friday's close.
Boeing shares (BA) are up 3.2% after the airplane maker reached deal to avoid a strike by more than 30,000 machinists.
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The chart
Most traders are aware that September tends to be a bad month for stocks. But it's usually the second half of the month that's worse. Jonathan Krinsky, technical strategist at BTIG, provides the chart below and asks whether investors have "front run" the narrative, "and that creates the set-up for some relief later this month."
Top tickers
Here were the most active stock-market tickers on MarketWatch as of 6 a.m. Eastern.
Ticker Security name NVDA Nvidia GME GameStop TSLA Tesla PLTR Palantir NIO Nio AAPL Apple TSM Taiwan Semiconductor Manufacturing AMC AMC Entertainment HOLO MicroCloud Hologram TNXP Tonix Pharmaceuticals
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-Jamie Chisholm
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