Market Insights from Morgan Stanley

Date: Prior to the last Federal Reserve meeting
Morgan Stanley had outlined a 50bp rate cut as a short-term scenario for equities that could avoid raising economic growth concerns.

In a Sunday note, strategists highlighted that Fed Chair Jerome Powell managed to maintain this balance, leading to positive responses in equities.

Equity Performance Factors

Morgan Stanley emphasized that over the next 3-6 months, equity performance is likely to be influenced more by labor data than other variables. As the next employment data release approaches, they suggest an upside surprise is necessary for a sustainable cyclical rotation in the U.S. market.

“To be specific, we think the unemployment rate probably needs to decline alongside above-consensus payroll gains, with no material downside revisions to the prior months,” strategists wrote.

Key Indicators to Monitor

Besides labor data, several indicators are being monitored:
– Earnings revisions breadth serves as a proxy for company guidance; currently, while the S&P 500 remains flat, the Russell 2000 and lower-quality sectors are trending negatively.
– The ISM Manufacturing PMI has shown stagnation, but ISM Services is more resilient.
– Leading Economic Indicator and Employment Trends Index are in clear downtrends.

The document notes that such data suggest it’s a later-cycle environment, advising investors to focus on cap and quality curves amid surprise policy stimulus from China.

Impact of China’s Stimulus

While China’s measures might not significantly influence U.S. growth or labor dynamics, Materials and Industrials stocks could gain short-term benefits.

Fiscal Concerns

Morgan Stanley reports that August’s budget deficit exceeded forecasts by $90 billion, creating concerns over fiscal sustainability. This deficit-led fiscal stimulus has bolstered growth but may have crowded out private economic sectors.

Investment Landscape

• Gold has performed well, outpacing the S&P 500, alongside high-quality real estate and inflation hedges.
• On the contrary, lower-quality assets, including small-cap stocks and profitless growth companies, have struggled.

Looking Ahead

To reverse current trends, there must either be a reacceleration in private sector growth or a recession to reset prices. Absent either scenario, a soft landing remains the base case.

In summary, the Fed’s significant rate cut may stabilize lower-quality cyclical stocks temporarily, yet continued improvements in labor data and other growth indicators are vital for sustaining these trends toward year-end.