Bad economic news has been good for stocks, but that could change this week

So far, the bad economic news has mostly been positive for the stock market, as investors worry that the Federal Reserve will start cutting interest rates. There is, however, a danger of overdoing it, as too much bad news can signal a significant recession and even a future recession. This is the dilemma the market finds itself in as it approaches a week of critical data, focusing mainly on the all-important US labor market, which in turn provides signals about consumer health. “Bad news has been good news for stocks over the past two months… but if growth deteriorates too much, the bad news could turn into bad news,” said Ohsung Kwon, equity and quant strategist at Bank of America, in a note to customers. Monday. Kwon points out that during this period, the S&P 500 and the US dollar diverged in almost perfect unison. The dollar index has seen a steady, albeit gradual, decline, while the large-cap stock index has seen a similar, steady, yet gradual increase. The trend became particularly acute last month, when the S&P 500 rose about 3%. The dollar often rises on bad news as investors seek the safety of cash and cash equivalents, while the stock market gains on good news. .SPX .DXY line 2024-04-01 Stocks versus dollar At the same time, economic data generally deteriorated, or at least did not meet Wall Street’s forecasts. The Citi Economic Surprise Index, which measures actual data against consensus expectations, began to decline in mid-April, turning negative at the end of May, dropping around 120%. The countercyclical measure indicates that expectations were exceeding reality. In most cases, bad economic news will likely help convince the Fed that the time is right to start cutting interest rates. The only exception is higher inflation, which would push the Fed toward tighter monetary policy. The central bank has maintained its benchmark interest rate in a range of 5.25%-5.5% since July 2023, the highest level in around 23 years. Fears about a more aggressive Fed on inflation have caused several bouts of volatility in the stock market. This leads the market into this week’s data series, which includes surveys on job openings and private job creation, concluding on Friday with the Bureau of Labor Statistics’ nonfarm payrolls report. Economists consulted by Dow Jones expect a growth of 178 thousand jobs for the month, which would be close to the 175 thousand in April, and would probably keep the unemployment rate at 3.9%. If the estimate is correct, it would put job creation in the “Goldilocks range” of 125,000 to 175,000, meaning neither too hot nor too cold, according to experts at Bank of America. However, anything below 125,000 could mean a reversal of the bad news is good news trend, in which a rise in the unemployment rate could trigger a parameter known as Sahm’s Rule, the bank said. Created by economist Claudia Sahm, from New Century Advisors, the rule states that if the average unemployment rate over three months is half a percentage point higher than the 12-month minimum, the economy is in the early stages of recession. In May, the minimum of the last 12 months would be 3.5%, which means that the unemployment rate would have to remain at a three-month average of 4% to meet the Sahm barrier. Based on the previous two months, the unemployment rate would have to rise to 4.3% in May for this to happen. However, Bank of America considers this unlikely, expecting 200,000 job growth above consensus. “As long as inflation remains under control, stronger growth should also be positive for stocks,” Kwon wrote. Still, BofA’s strategy team expects market volatility around the report and believes the market is underestimating the possibility of a market move. The company recommends an options strategy known as a “straddle” as a way to capitalize on a potential market swing. The move involves purchasing S&P 500 puts and calls that expire on the same day and have the same strike price. It pays off when the index rises or falls relative to the strike price by more than the premium paid. BofA said trading ended in the money six of the previous eight weeks.

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