Here’s the key reason why a half-point cut would actually wholesale stocks, according to Morgan Stanley’s top strategist

By Jamie Chisholm

Critical information for the US trading day

Futures early Monday suggest the US stock market may try to recover somewhat after the S&P 500 SPX dropped 4.25% in the previous four trading days, its worst – although 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 US economy determines. 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 realize 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 belief the Fed is behind the curve from an easing standpoint.”

And now Wilson fears the stock market is increasingly worried 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 US front end rates could cause the yen to strengthen further, thus eliciting an adverse reaction in US 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

US 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 $2,497 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

For more market updates plus actionable trade ideas for stocks, options and crypto, subscribe to MarketDiem by Investor’s Business Daily.

The buzz

US economic data due on Monday include wholesale inventories for July at 10:00 am Eastern, and August consumer credit at 3:00 pm

Apple (AAPL) will show off its new iPhone 16 model at an event starting 1:00 pm Eastern.

Oracle (ORCL) will present earnings after Monday’s closing bell.

Shares of Palantir Technologies (PLTR) are up 7% in premarket action, and Dell Technologies (DELL) are gaining 6% and after the stocks were added to the S&P 500 index after Friday’s close.

Boeing shares (BA) are up 3.5% after the airplane maker reached a deal to avoid a strike by more than 30,000 machinists.

Best of the web

The mysterious, meteoric rise of Shein.

Musk’s xAI has discussed deal for share of future Tesla revenue.

Biden and Trump are both eyeing a sovereign-wealth fund. Why?

The greyhound

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 am 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

Random reads

A literal Russian fat cat.

How Victorian female police cracked crime.

When a beauty pageant turned ugly.

Need to Know starts early and is updated until the opening bell, but sign up here to get it delivered once to your email box. The emailed version will be sent out at about 7:30 am Eastern.

Barron’s Roundtable: Prepping the Power Grid for the Future. As the fossil-fuels economy gives way to the electrification revolution, America’s electric grid is in for an overhaul. Join us for an exploration of the challenges and opportunities ahead. REGISTER HERE for the virtual event.

-Jamie Chisholm

This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.

(END) Dow Jones Newswires

09-09-24 0633ET