Underperforming stocks could catch up if the latest jobs data turns out to be strong

• Morgan Stanley thinks the next jobs report could extend the stock rally beyond the technology sector.
• The company expects an additional 185,000 nonfarm jobs, exceeding consensus forecasts.
• A strong jobs report “will give markets greater confidence that upside risks have subsided.”

Mike Wilson, chief U.S. equities strategist at Morgan Stanley, said another round of jobs data could give a boost to underperforming stocks.

The recent stock market rally, fueled by AI investments, has pushed the S&P 500 up about 20% and the Dow Jones Industrial Average up about 6,000 points over the past 12 months, but many other names have lagged behind the tech-fueled enthusiasm.

That could change if the next nonfarm payroll data due next Friday proves better than expected, Wilson said.

“Higher-than-expected wage data and a lower unemployment rate would likely provide markets with greater confidence that upside risks have subsided, paving the way for sustained high equity valuations and a potential catch-up in some other markets/stocks,” Wilson wrote in a note Tuesday.

Morgan Stanley analysts predict that the U.S. added 185,000 nonfarm payroll jobs in August, exceeding the market consensus of 162,000 and up from an additional 114,000 jobs in July.

The bank forecast the unemployment rate would fall to 4.2%, in line with consensus. That’s a small drop from July’s 4.3% rate, which was a surprise rise from June’s 4.1%.

Wilson said if the employment report falls short of expectations for a second straight month, it could spark renewed fears of a recession.

“Conversely, another weak report and a further rise in the unemployment rate would likely reignite growth concerns and put pressure on equity valuations, similar to what happened last month,” Wilson said.

Weak jobs data could also force the Federal Reserve to cut interest rates more than expected.

Wilson said a series of 25 basis point cuts “could be a sweet spot for the equity multiple if it comes alongside solid growth,” while a 50 basis point cut “may not be viewed positively by the equity market if it comes alongside labor market weakness.”

The stock market has surged in recent months as investors have become increasingly cautious about the returns on AI investments, with spending expected to increase by $1 trillion in the coming years.

That was evident last week, when Nvidia extended its post-earnings decline to 13% since its earnings report on Thursday, with results falling short of its most ambitious targets and investors still questioning the return on its AI investments for the chipmaker’s customers.

Bloomberg data shows that as other industries catch up, about 16% of S&P 500 stocks are now rising to 52-week highs, up from 4% at the start of the year.