Morgan Stanley says the latest jobs report confirms the economy is in the early stages of a “rolling recovery.”
The downturn in U.S. jobs growth is actually a sign of an economy bottoming, rather than deteriorating into a recession, say Morgan Stanley stock-market strategists.
“We’re not of the view that a rapid/acute rise in the unemployment rate and/or significantly negative payroll numbers are coming unless we were to see another shock to the economy,” said a team led by Mike Wilson, chief U.S. equity strategist.
Nonfarm payrolls rose a weaker-than-forecast 22,000 in August, alongside a downward revision for June although an upward revision for July. The data appeared to seal the deal for a September Fed rate cut.
“Friday’s jobs data and improvement in revisions means June is the latest low point for payrolls this cycle, though other measures we track suggest labor weakness was most prevalent around Liberation Day-the trough of the rolling recession, in our view,” they said.
Wilson and his team have maintained that a U.S. recession began in 2022 and bottomed on “Liberation Day,” and say the recent jobs data offers further proof that the economy is now in the early stages of a recovery.
The initial phase of this was led by tech and consumer goods, which benefited massively from COVID-related stimulus, followed by most sectors of the economy passing through individual recessions at their own pace, they said. “This is a key reason why we never got the typical spike in the metrics used to define a traditional recession.”
A V-shaped rebound in earnings revisions breadth – a measure of analysts who have raised estimates minus those who have lowered them – also lends to that recovery view, the strategists said. Those types of inflections higher have only happened after recessions and not before, i.e. early-cycle transitions, they added, offering this chart.
Investors rattled by the latest jobs numbers should remember “labor data are always late to the party and by the time they confirm we are in a downturn, it’s typically after the equity market has figured it out.”
They do see near-term risk for stocks surrounding whether the Federal Reserve can mount a big-enough response, though.
“With the Fed still focused on the potential for inflation and the labor data weak, but not ‘bad enough,’ there are questions in terms of just how much the Fed can cut in the near term,” they said. Investors could see choppy markets into the weak seasonal September/October window, but any consolidation would “set up a strong finish to the year and 2026, given our conviction for a durable and broad economy,” they believe.
Morgan Stanley suggests investors looking for a defensive hedge stick to big-cap healthcare stocks, as earnings revisions strengthen for pharma/biotech and healthcare equipment/services.
A proper-rate cutting cycle could also turn the tide for small-cap stocks, said Wilson and his colleagues, who upgraded small-caps to neutral from underweight last week. The Russell 2000 RUT is up 7.2% this year versus a 10% gain for the S&P 500 SPX.
“Given the risk that the Fed may still be focused on inflation more than the weakness in the labor market, rate cuts may materialize more slowly than is necessary to catalyze a durable rotation to lower quality small cap names in the near term,” they said.
While worsening jobs data would drive a more dovish Fed reaction needed to spur a rotation into small-caps, that could “take at least a few more months, given the lagged nature of these data.”
