Morgan Stanley
  • Wealth Management
  • Jun 17, 2019

Don’t Chase the Bad News Bulls

Markets are rising as investors interpret weak U.S. economic data as improving the odds for a Fed rate cut. That’s not a great reason to buy the rally.

After a May swoon, U.S. markets have rebounded nicely in June, with the benchmark S&P 500 back within a couple of percentage points of its all-time high. Much of the newfound optimism rests on the Federal Reserve having recently indicated that it may start cutting interest rates again for the first time in years to help lift flagging economic growth.

This has contributed to a “bad news is good news” dynamic in markets, where investors have interpreted weak economic data as a positive simply because it increases the likelihood that the Fed will soon cut rates to forestall a potential recession.

Such thinking can lead to a dangerous complacency among investors. As I wrote last week, investors may be overestimating the positive impact of a rate cut and should remain cautious. Below are three recent negative economic data points that may have (ironically) contributed to stock market gains:

  • Disappointing jobs market data: On June 7, the government reported that nonfarm payrolls grew by 75,000 in May, far below the consensus analyst estimate for job gains of 180,000, and only a fraction of the 224,000 new jobs added in April. We believe U.S. employment has peaked.

  • Falling inflation rate: While the Fed considers inflation of 2% healthy for a growing economy, a key barometer of inflation derived from personal spending, the PCE, recently dipped to 1.6%. Low inflation can be a symptom of low consumer demand and high unemployment. Based on Treasury market prices, it’s clear that bond traders see little chance of the kind of reflation that could lift equity prices. I think that’s a signal worth listening to.

  • Slowing economic growth: GDP forecasts are falling, not just in the U.S., but globally, weighed down by persistent trade tensions. According to consensus estimates, economists now expect 2019 U.S. GDP growth to fall from 3.1% in the first quarter to 2.4% in the second quarter, 2% in the third and 1.8% in the fourth.

None of these indicators signal pending economic disaster. Indeed, part of my concern with markets now is that futures prices already reflect the impact of several rate cuts, with the first one potentially happening as soon as July. They may not all materialize as expected. My research suggests that the best time to invest is after the third or fourth cut, not ahead of the first one.

Plus, I’m somewhat dubious about the general concept that the Fed can provide “insurance” against a market downturn with rate cuts. It may just inflate asset bubbles (we saw that in 1998) while doing little to boost the broader economy. I suggest investors maintain fixed-income positions as ballast against potential downside in stocks. Markets are up, but it’s way too early to embrace an all-clear signal.

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