Cautious Moves for a Short-Sighted Market

Nov 22, 2023

Traders are anticipating a year-end equity rally, but longer-term investors may want to remain cautious. Here’s why.

Lisa Shalett

Key Takeaways

  • Short-term traders are bidding up stocks in anticipation of interest-rate cuts by the Federal Reserve and a 2024 rebound in company earnings.
  • However, rate cuts would likely only come amid slowing growth and rising unemployment, which would hurt corporate profitability.
  • Value-oriented long-term investors may want to consider opportunities in financials, U.S. small- and mid-cap stocks, and international equities.

Are you an investor or a trader? The answer will determine how you should respond to financial market conditions right now.


Morgan Stanley’s Global Investment Committee believes that we are currently in a “traders’ market,” in which speculative traders may enter and exit positions more frequently, driving market volatility and range-bound index performance. This stands in sharp contrast to an “investors’ market,” in which investors tend to buy and hold assets over an extended period, helping to drive long-term positive performance across stocks and sectors.


What conditions indicate that we’re in a traders’ market today? Consider that the S&P 500 Index has been on a rollercoaster of volatility over the past two years, trading between 3,500 and 4,800, and today is still no higher than at the end of 2021. Granted, stocks are having a relatively good month so far, but the current rally seems to be running on the rosy, oft-repeated conjecture of many traders: The U.S. Federal Reserve will soon declare victory over inflation and begin cutting interest rates as the economy enjoys a “soft landing” of stable growth and employment.


We believe that view is based on at least two myopic assumptions: 


1.   The Fed will lose its resolve and cut interest rates before inflation has fallen to its 2% target. October consumer-price-index (CPI) data showed that “core” inflation, which excludes volatile food and energy prices, was 0.1 percentage point below analyst estimates. While investors cheered this positive direction, core inflation is still at 4%, twice the Fed’s target, and more progress is needed to bring down inflation in the services sector, where prices can be “sticky.” Also, while a cooling economy with rising unemployment would likely allow inflation to fall further, giving the Fed justification to cut rates, it would also likely weigh on company earnings and equity valuations.


2.   Earnings growth will come roaring back. It seems that many investors are willing to look beyond near-term weakness in corporate earnings, anticipating about a 12% increase in profits for 2024. But, as noted above, corporate profits remain vulnerable to economic conditions, and many analysts have already begun cutting their forecasts for future earnings. Also note that S&P 500 companies, in aggregate, saw sales growth of only 1.4% in the third quarter of 2023, despite 8% nominal GDP growth. What happens when nominal GDP growth drops to 4%, as is forecast over the next few quarters?


Despite these risks, positive momentum in equities seems to prevail. Markets may indeed rally out the remainder of the year, during a period that historically tends toward positive U.S. stock returns.


Still, in a traders’ market, investors who are focused on the long term need to be wary of chasing this momentum. Be cautious of potential disappointments that are not reflected in current lofty valuations and hopeful earnings expectations. And consider taking advantage of today’s market volatility to implement tax-management strategies, like tax-loss harvesting.


Look for investments that provide yield and companies that have quality cashflows and realistic earnings goals. Value-oriented opportunities may be found among financials, U.S. small- and mid-cap stocks, and international equities.


This article is based on Lisa Shalett’s Global Investment Committee Weekly report from November 20, 2023, “Anticipating the Anticipation.” Ask your Morgan Stanley Financial Advisor for a copy. Listen to the audiocast based on this report.

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