Investors Cheer Bad News for the Economy

May 22, 2024

Investors are treating drops in inflation and downturns in jobs as good news for markets. But how much longer will this strategy work?

Lisa Shalett

Key Takeaways

  • Many investors are cheering recent signs of cooling inflation and a softening labor market, in hopes for more Fed rate cuts.
  • However, further evidence of a slowing economy could eventually begin to weigh on markets.
  • Investors should watch for a potential slowdown in consumer spending and focus on balance and diversification in their portfolios. 

Can bad news for the economy be good news for markets?


That’s the way investors seem to be thinking these days, as they cheer signs of economic slowing, believing it will keep the Federal Reserve on track to cut interest rates this year. Alongside a modest cooling in inflation in April, recent data has shown some softening in the labor market:


  • U.S. employers scaled back hiring in April, as nonfarm payrolls rose 175,000 last month. That’s the smallest increase in six months and below market expectations of 240,000.
  • The unemployment rate rose to 3.9% versus analysts’ estimate of 3.8%.
  • U.S. job openings fell in March to 8.49 million, the lowest level in three years, while the so-called quits rate fell to 2.1%, the lowest since 2020.


Taking these soft economic readings as potentially good news, investors sent the S&P 500 Index to another all-time high last week. Treasury bond yields, meanwhile, have fallen alongside a rebound in expectations for Fed rate cuts. After pricing as few as just one cut this year, fed funds futures now indicate expectations for more than two by January 2025.


Investor complacency seems to be running high. The CBOE Volatility Index, or VIX, known as the stock market’s “fear gauge,” is near a five-month low, around 12, well below its long-term average of 19.6.

Bad News Can Turn Bad Again

When potential changes in monetary policy loom large in investors’ decision-making, as they do currently, investors typically view bad news for the economy as good news for markets, and vice versa. However, history suggests that too much bad news eventually becomes just that—bad news—and investors risk being caught unprepared when the tide turns.


So, what should investors be watching? Our current focus is on U.S. consumers, whose spending powers more than two-thirds of the national economy. Data here paints an increasingly fragile backdrop.


  • The University of Michigan’s consumer sentiment survey posted an overall reading of 67.4 for May, down from 77.2 in April and far below estimates for 76. Sentiment around both economic conditions today and those expected in the future fell notably.
  • The same survey showed consumers now anticipate higher inflation over the next year, with the outlook jumping to 3.5%, the highest level since November 2023, up from 3.2% a month earlier.
  • Retail sales stalled in April, while the first-quarter earnings results of consumer-oriented companies have shown customers’ exhaustion with higher prices.
  • Meanwhile, excess savings for the lowest income households are becoming depleted, while delinquencies on credit cards and auto loans are rising.

How to Position Portfolios

For now, investors appear positioned only for a soft landing, in which inflation cools and the economy slows without a recession. However, Morgan Stanley’s Global Investment Committee believes the odds of that scenario have fallen, while the chances have increased for both of two opposing scenarios: either a hard landing, with the economy going into recession, or no landing, with the economy continuing to grow. The discrepancy indicates how murky the outlook has become.


With markets maintaining that “bad news is good news” in the current uncertain environment, we recommend that investors focus on finding balance. Consider active stock picking across sectors, focusing on companies with high-quality cash flows and achievable earnings targets. Also consider adding investment-grade credit and a form of “insurance” via options on the VIX, which may benefit investors depending on whether equity volatility rises or falls, or puts on the S&P 500, which may help hedge a portfolio from sharp drops in the stock index.


Finally, consider potential portfolio diversifiers including international equities and real assets, such as gold, real estate investment trusts (REITs), master-limited partnerships (MLPs) and commodities.


This article is based on Lisa Shalett’s Global Investment Committee Weekly report from May 20, 2024, “For Now, Bad is Good.” Ask your Morgan Stanley Financial Advisor for a copy. Listen to the audiocast based on this report.

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