When bad news is good news for U.S. stocks

With second-quarter earnings season now largely behind the U.S. market, stock investors have been focusing on the latest economic data and for the most part been reacting positively to bad economic news, or any data that may point to an economic slowdown. 

It’s been almost nine months since the trend emerged, as softening economic data and lower inflation may mean the Federal Reserve can stop raising interest rates.

Traders are reportedly pricing in an over 90% chance that the Fed will hold its policy interest rate unchanged at its September 2023 meeting, and a roughly 35% likelihood that the U.S. central bank will raise interest rates by 0.25% in November 2023.

Fed policy weakening?

The Fed’s monetary policy has lost some of its potency and interest rates may need to rise as a result, economists say.

U.S. stocks closed higher ahead of the Labour Day holiday weekend, after data released indicated a cooling labour market, though there was speculation that summertime jobs data may have been a factor. The U.S. created 187,000 new jobs in August, while the unemployment rate jumped to 3.8% from 3.5%.

The data supports the narrative of a gradual slowdown in the U.S. labour market, but there are no dramatic signs that the economy is weakening significantly economists say. The economic data has not been bad. It is just softening.

‘Good news bad news, bad news good news’!

However, if investors see a significant decline in the housing and U.S. labour markets, that could change the narrative and break the cycle in which ‘bad economic news is good news’ for stocks, economic data have to be much worse than now, indicating more damage from high interest rates and higher inflation.

The trend may also reverse if there is a meaningful downgrade of corporate earnings ‘expectations’ and then this translates into weakened profitability.

Inflation just may climb again

Investors should also be alert for the possibility that inflation may accelerate again. Data showed that the personal consumption expenditures price index rose 0.2% in July, but the yearly inflation rate crept up to 3.3% from 3%. Inflation has been trending down but that trend could turn again.

If investors start to treat ‘bad economic news as bad news’ for the stock market, it could put pressure on the 2023 stock-market rally, with the S&P 500 SPX already up 17.6% since the start of the year and the Nasdaq Composite COMP up 34%.

General concensus is that the bull run ain’t over just yet.

Just keep an eye on the data…

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