Financial Professionals

May 28th, 2024

Does The Whipsaw Stock Market Signal Bad News…Or Good News?

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Is “Bad News Good News” for the U.S. Economy?

U.S. stocks have been on a volatile ride over the past six weeks or so. In April, the S&P 500 sold off sharply, posting a 4.2% decline. But equity prices have moved the other way this month, with a “v-shaped bounce” pushing the S&P 500 to new all-time highs. So much for “sell in May and go away.”1

The financial media has a tidy explanation for the market whipsaw. April’s selling pressure was due to higher-than-expected inflation in Q1, which lowered the likelihood of rate cuts this year. But fortunes reversed in May when April CPI did not show a reacceleration, and slightly weaker U.S. economic data—specifically in the jobs market and with April’s Services PMI—put rate cuts back on the table.

The takeaway for many is that “bad news is good news” again for the stock market since relatively weak economic data opens the door for the Fed to lower interest rates. In other words, weaker-than-expected jobs data was a major positive for stocks, which only seem to care about the prospect of looser monetary policy.

I don’t buy it.

For one, it is a bit premature to say the U.S. economy is in a weakening pattern, in my view. The April jobs report showed that employers added 175,000 new jobs for the month, which was below expectations for 240,000 jobs but still showed solid growth. A slight deceleration does not raise any alarm bells, and one month’s worth of data doesn’t tell us much about trends in the labor market. Overall, there are still about 2 million more open jobs than there are unemployed persons in the U.S., which I think signals the labor market remains tight.

Job Openings Still Outnumber Unemployed Persons by a Healthy Margin

Source: Federal Reserve Bank of St. Louis2

U.S. consumers have also not shown meaningful signs of pulling back on spending, and the May 16th estimate from the Atlanta Fed’s GDPNow forecasting tool projects 3.6% GDP growth in the current quarter. If there’s bad news about U.S. economic activity that’s significantly raising the likelihood of rate cuts soon, I’m not aware of it.

On the contrary, I would posit that “good news has been good news” for stocks in May, and it’s been coming in the form of robust corporate earnings.

Zacks is anticipating year-over-year earnings growth of roughly 5%, which marks the third consecutive quarter of growth. We’ve also noted from earnings calls that CEOs are talking about inflation and recession risks far less than they were in 2022. In that year, some 90% of S&P 500 companies cited inflation in earnings calls, and up to 40% mentioned “economic slowdown.” In Q1 2024, just over half of companies mentioned inflation risks and less than 10% referenced an economic slowdown.

Additional signs that executives are feeling more confident about the macroeconomic outlook include higher capital expenditures (CapEx) and more stock buybacks. According to Business Roundtable’s CEO survey, 40% of CEOs expected to increase investments in the next six months, the highest since Q4 2022 and up 32% from Q4 2023. As seen in the chart below, business investment has been strong in recent periods.

Business Investment, Change in Billions of Dollars

Source: Federal Reserve Bank of St. Louis3

As for share buybacks, S&P 500 companies announced nearly $200 billion in share buybacks in Q1, a 16% increase from the same period in 2023. Some 443 companies have announced plans to buy back shares, which is up from 378 a year ago. By some estimates, S&P 500 share buybacks could reach $925 billion in 2024, an annual growth rate of 13%.

Bottom Line for Investors

Obsessing over monthly economic data and its potential impact on Fed policy is not an effective outlook in my view. Investors can frame April’s pullback and May’s recovery in terms of shifting expectations around interest rates, but doing so means ignoring stocks’ main driver—earnings. Since 2020, earnings have contributed almost three-quarters of the S&P 500’s 70+% return.

Looking ahead, we expect S&P 500 companies to grow earnings by 9% in 2024. If companies deliver better-than-expected results, I’d expect more upside from stocks, too—whether the Fed cuts rates this year or not.

Disclosure


1 Wall Street Journal. May 21, 2024. https://www.wsj.com/finance/this-stock-market-rally-isnt-what-it-seems-602b0feb?mod=djemMoneyBeat_us

2 Fred Economic Data. May 1, 2024. https://fred.stlouisfed.org/series/JTSJOL

3 Fred Economic Data. April 25, 2024. https://fred.stlouisfed.org/series/PNFI

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