The Resilience of the Stock Market

With equity markets showing strength in the face of slowing growth, investors are left wondering how, or if, they can remain resilient.

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Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross Assets Strategist for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape and how we put those ideas together. It's Friday, April 21st at 2 p.m. in London. 

Meeting with investors over the last several weeks, there's one question above all others that seems to be on people's mind. In the face of slowing growth, tightening policy, banking sector stresses and uninspiring valuations, why are markets, especially equity markets, so resilient? 

Like many things in the market, there is no one reason, and it's also impossible to know for sure. But we have some suspicions about what is and isn't behind the strength and what that means going forward. 

One trio of factors rolled out to explain this resiliency, is the idea that growth and earnings are holding up well, the Fed is once again injecting liquidity into the system, given recent banking sector challenges and investors are already so negative that the risks are well known. Yet each of these explanations seems to come up a little short. 

Global growth in the first quarter was better than expected, but markets should care more about the forward looking outlook, which looks set for deceleration, while estimates for corporate earnings have generally been falling throughout the year. While the Fed did provide extra liquidity given recent banking sector challenges, this looks very different from traditional quantitative easing, especially as the banks continue to tighten their lending activity. And while sentiment feels cautious, perhaps as evidenced by the popularity of this question, measures that try to quantify that fear have generally normalized quite a bit and look a lot closer to average than extreme. 

So what do we believe is going on? First, the stock market is often seen as a broad proxy for the economy or risk appetite, but in 2023 it's been unusually swayed by a small number of very large stocks in the U.S. and Europe. That still counts, of course, but it makes drawing broad conclusions about what the stock market is doing or saying a lot more difficult.

Second, recent banking issues created an odd dynamic where markets could celebrate the possibility of easier central bank policy almost immediately, while the real economic impact of tighter lending standards arrives at some uncertain point in the future. That provides an immediate boost for markets, but the fundamental challenges of that tighter bank lending are still to come. 

Third, and just as important, the market tends to take a view that the end of central bank interest rate increases will be a positive. That is what the data says if you look across all hiking cycles since, say, 1980. But if you only look at times when the yield curve is inverted and the Fed has stopped hiking, like it is today, the picture looks a lot less rosy. 

Market resilience has likely had several drivers. But with measures of sentiment starting to look more balanced, growth still set to slow and markets already expecting easier central bank policy than our economists expect, we think the outlook remains challenging as we look beyond April.

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