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Wednesday, April 7, 2021

Bursts of economic activity can put stocks under pressure

As readers of the Morning Brief know, the U.S. economy has been exceeding expectations left and right.

But a few pieces of Wall Street commentary over the last several days have noted that bursts of economic activity on this scale historically put the market under some pressure.

Which could set the stock market up for a correction of sorts in the months ahead.

As my colleague Brian Sozzi highlighted in a piece on Yahoo Finance on Tuesday, Deutsche Bank's Binky Chadha notes that the recent spike in activity measures from the Institute for Supply Management — which the Morning Brief covered here and here — suggest a flattening out or peaking of activity in the coming months. And after accelerations higher, these moderations in economic activity have typically been accompanied by modest declines in the stock market.

"Growth (ISM) typically peaks around a year (10-11 months) after recession ends, right at the point we would appear to be," Chadha writes. "A majority of historical peaks in growth (two thirds) were inverted-V shaped, while the rest saw the ISM flatten out at an elevated level. The S&P 500 sold off around growth peaks by a median -8.4%, but even episodes which saw the ISM flatten out rather than fall, saw a median -5.9% selloff."

Earlier this week, Charles Schwab strategist Liz Ann Sonders also flagged work from analysts over at Goldman Sachs who note that when the ISM's manufacturing activity reading exceeds 60, the S&P 500 tends to be lower over the next three- and six-month periods. In March, the ISM's manufacturing activity index registered a reading of 64.7.

And these firm data points help bring into focus an idea that has been percolating through the Morning Brief in recent weeks, which is that what is good for the U.S. economy and daily life normalizing after the pandemic shock might not be great for markets. These data also serve as another way to say, as we did last week, that what has been working over the last year might not work in the months ahead.

"At this point, the bullish narrative of a recovering/reopening economy is very much the consensus view," Morgan Stanley's Mike Wilson said in a recent note. "That doesn't make it wrong, but markets are discounting machines and may already reflect the recovery from last year's sharp recession."