By Steve Goldstein
Equities face turbulence as tightening liquidity collides with a peak in the rate of change for earnings revisions, says Mike Wilson and team
The stock market faces a big test, and the Fed may not provide the answers, argue Morgan Stanley strategists.
The long weekend saw a flurry of is-it-open or is-it-closed headlines with regard to the Strait of Hormuz, but the bottom line, for markets, is that the U.S. and Iran are still talking and oil tankers are starting to move out of that restricted waterway.
Besides Iran, one of the other unresolved issues for markets is whether the Federal Reserve under Kevin Warsh has taken a new hawkish turn or just employing more hawkish language. Lori Calvasina, head of U.S. equity strategy at RBC Capital Markets, said the uncertain outlooks for the Fed and the Middle East were the big talking points among Canadian-based investors in U.S. stocks she spoke to last week.
The stock-market strategists at Morgan Stanley, led by Mike Wilson, say things are playing out just as they expected back when President Donald Trump first announced the Warsh nomination. “We viewed the selection of Warsh as the right choice to fortify market credibility for the Fed, a critical element for the eventual success of the administration’s plan to grow out of the debt problem,” said the strategists.
Wilson and team argue the subsequent move in the ratio of the S&P 500 SPX to gold (GC00), up 40% since Warsh was nominated, supported their analysis. “In short, the Warsh nomination was the right choice if the goal is to fortify some questioned credibility for policy makers as evidenced by the moves in precious metals earlier this year and over the past decade,” they said. Warsh’s press conference on Wednesday – criticizing his colleagues for having missed the Fed’s inflation target of the last five years – suggests “there is a new sheriff in town that will enforce that mandate.”
Granted, he also suggested that the Fed’s inflation target is due to be amended, with his comment that he tends to focus on the left of the decimal point, though Warsh said “for now” the central bank’s inflation target is still 2%. The Morgan Stanley strategists say the comment means Warsh is aware of the need to run the economy “hot to some extent” to manage the debt problem in the long term.
But now, they say, comes the hard part. Warsh didn’t comment much about the balance sheet – its future use is the subject of one of his five task forces – but the strategists highlight that the rate of change on the balance sheet has rolled over. The Fed reduced the size of its reserve management program from $40 billion per month to $10 billion, at the same time Treasury buybacks have been curtailed by about 50%. On top of that, lending growth is accelerating.
“Net-net, we believe the path on liquidity is already tightening and think it is unlikely to reverse in the absence of funding market stress, higher bond volatility or credit market disruption. In other words, liquidity remains the greater risk to equity markets in the short-term rather than any fears about the Fed raising rates to fight inflation,” they say.
This liquidity drying up will interact with the rate of upward earnings revisions slowing down. And that could mean the market testing Warsh’s new commitment, possibly over the next few weeks, to take short-term pain to achieve longer-term goals, they warn.
The market
U.S. stock-market futures (ES00) (NQ00) were mixed. Asian stocks rallied, buoyed by tech stocks in Japan and Taiwan. Treasury yields BX:TMUBMUSD10Y rose. Oil futures (CL00) fell.
Key asset performance Last 5d 1m YTD 1y S&P 500 7500.58 1.44% 0.74% 9.57% 25.41% Nasdaq Composite 26,517.93 2.74% 0.86% 14.09% 35.67% 10-year Treasury 4.49 0.10 -7.30 31.80 10.70 Gold 4226.8 -2.41% -6.29% -2.43% 24.89% Oil 75.13 -7.43% -22.55% 30.87% 11.77% Data: MarketWatch. Treasury yields change expressed in basis points
The buzz
Senior negotiators from the U.S. and Iran on Monday wrapped up two days of talks in Switzerland as Pakistan and Qatar said technical negotiations would continue.
Resuming energy production isn’t easy, as evidenced by an explosion in Qatar after restarting a gas export terminal. Exxon Mobil (XOM) has a stake in the plant.
U.K. Prime Minister Keir Starmer announced he’ll resign as soon as a successor is in place.
The deadly rise of giant trucks and SUVs
The chart
The 2-month rolling correlation between 10-year U.S. Treasury yields and the S&P 500 currently stands at the lowest level since 1996, says UBS economist Arend Kapteyn. Deeply negative equity-yield correlations typically occur during periods of elevated inflation, he says, and historically also signalled higher bond volatility relative to equity volatility.
Top tickers
Here were the most active stock-market tickers on MarketWatch as of 5 a.m. Eastern.
Ticker Security name SPCX Space Exploration Technologies Corp. NVDA Nvidia MU Micron Technology TSLA Tesla TSM Taiwan Semiconductor Manufacturing Co. INTC Intel AMD Advanced Micro Devices MSFT Microsoft GME GameStop INFY Infosys
-Steve Goldstein
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06-22-26 0655ET
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