Podcast Summary: "Why Stocks Get Ahead of the Fed"

Podcast Information:

• Title: Thoughts on the Market
• Host/Author: Morgan Stanley
• Episode: Why Stocks Get Ahead of the Fed
• Release Date: August 4, 2025
• Description: Short, thoughtful, and regular takes on recent events in the markets from a variety of perspectives and voices within Morgan Stanley.

Introduction

In the August 4, 2025 episode of Thoughts on the Market, Morgan Stanley's Chief Investment Officer and Chief U.S. Equity Strategist, Mike Wilson, delves into the intriguing phenomenon of why stock markets often outpace responses to Federal Reserve (Fed) policies. Titled "Why Stocks Get Ahead of the Fed," the episode provides a comprehensive analysis of recent market behaviors, economic indicators, and the interplay between equities and monetary policy.

Relentless Stock Rally since April

Mike Wilson begins by highlighting the stock market's vigorous performance since April, noting an absence of meaningful pullbacks. "Since the lows in April, the rally in stocks has been relentless with no tradable pullbacks," he states (00:14). This sustained upward trajectory has bolstered his bullish stance, primarily driven by a V-shaped recovery in earnings revision breadth observed since mid-April.

Factors Driving the Earnings Revision Rebound

Wilson attributes the rebound in earnings revisions to several key factors:

• Diminished Tariff Concerns: A reduction in bearishness regarding tariffs has fostered a more favorable environment for corporate earnings.
• AI Capital Expenditure (Capex) Cycle: The bottoming out of the AI-driven Capex cycle has contributed positively.
• Weaker US Dollar: A depreciating dollar has enhanced the competitiveness of US exports, benefiting earnings.

Additionally, the implementation of significant tax savings from recent legislation has improved cash flow prospects, paving the way for increased capital spending. "Cash tax savings from the one big beautiful bill are an additional benefit to cash flow, which should drive higher capital spending in May," Wilson explains (00:34).

Stocks Anticipate Positive Sentiment Over Lagging Economic Data

A central theme of the episode is the tendency of stock markets to lead positive sentiment ahead of delayed economic data releases. Wilson emphasizes that despite recent weak labor data, the long-term outlook remains optimistic. "Weak labor data last week may worry some investors in the short term, but ultimately we see this as just another positive catalyst for stocks," he notes (00:54).

Labor Data as a Backward-Looking Indicator

Wilson discusses the implications of weak labor data, suggesting that such figures often prompt expectations of Fed rate cuts. "Further deterioration would simply get the Fed to start cutting rates sooner and more aggressively," he asserts (01:10). The bond market aligns with this sentiment, currently pricing a 90% probability of a Fed rate cut in September, with the two-year Treasury yield notably trailing the Fed funds rate by 80 basis points—a much narrower spread compared to last summer's 200 basis points (01:23).

However, Wilson cautions that if upcoming labor data continues to disappoint, this spread may widen further. He underscores that economic data, particularly labor figures, are inherently backward-looking. "The labor data is arguably the most backward-looking data series we follow. It's also why the Fed tends to be late with rate cuts," he explains (01:37).

Backward-Looking Data vs. Forward-Looking Markets

A significant portion of the discussion centers on the contrast between backward-looking economic indicators and the forward-looking nature of earnings revisions and equity markets. Wilson articulates that both labor and inflation metrics lag real-time economic conditions, which inherently delays Fed responses. "Inflation metrics are arguably the second most backward-looking data, which explains why the Fed also tends to be late in terms of hiking rates," he states (02:00). He views this delay as a deliberate aspect of monetary policy rather than an oversight.

Furthermore, Wilson contends that the bond market's signals hold more influence over equity valuations than public statements from figures like former President Trump urging Fed Chair Powell to cut rates. "The bond market's influence is more important than President Trump's public calls for Powell to cut rates," he emphasizes (02:15). This dynamic is why equity markets often anticipate Fed actions at various stages of the economic cycle.

Historical Market Analysis and Market Bottom

Reflecting on the mid-year outlook, Wilson recalls April as a pivotal month where equities found a durable low, effectively pricing in a mild recession. He elaborates, "April was a very durable low for equities that effectively priced a mild recession. ... It also coincided with a major trough in earnings revision breadth" (02:40). This period marked the culmination of a prolonged bear market that had been extinguished by adverse conditions over the preceding year.

Wilson references "Liberation Day" as a symbolic moment when the final wave of bad news was absorbed, setting the stage for a new bull market driven by forward-looking earnings revisions. "Liberation Day marked the end of a significant bear market that began a year earlier," he explains (03:00). He underscores that while economic data remains pessimistic, the stock market's forward-looking nature allows it to thrive ahead of the Fed's policy shifts.

The Relationship Between Recessions, Unemployment, and Stock Margins

Addressing skeptics, Wilson points out that unemployment rates typically rise for about 12 months following the stock market's bottom. In recessionary periods, once growth risks are priced into the market, they become tailwinds for corporate margins and equity performance as positive operating leverage materializes alongside significant Fed rate cuts. "In a recession, once the growth risk is priced, it's ultimately a tailwind for margins and stocks as positive operating leverage arrives and the Fed cuts significantly," he states (03:30).

Conclusion

In conclusion, Mike Wilson posits that the current rebound in stock markets is a consensus view among investors who recognize the delayed but eventual supportive actions of the Fed. "Based on this morning's rebound in stocks, it looks like the equity markets agree," he affirms (03:40). He encourages listeners to consider the interplay of lagging economic indicators and forward-looking market dynamics when evaluating investment strategies.

Notable Quotes:

• Mike Wilson [00:14]: "Since the lows in April, the rally in stocks has been relentless with no tradable pullbacks."
• Mike Wilson [00:34]: "Cash tax savings from the one big beautiful bill are an additional benefit to cash flow, which should drive higher capital spending in May."
• Mike Wilson [00:54]: "Weak labor data last week may worry some investors in the short term, but ultimately we see this as just another positive catalyst for stocks."
• Mike Wilson [02:00]: "Inflation metrics are arguably the second most backward-looking data, which explains why the Fed also tends to be late in terms of hiking rates."
• Mike Wilson [03:40]: "Based on this morning's rebound in stocks, it looks like the equity markets agree."

Final Thoughts

Mike Wilson's analysis in this episode offers valuable insights into the complex relationship between economic data and stock market movements. By emphasizing the forward-looking nature of equities and the lag inherent in monetary policy responses, he provides listeners with a nuanced understanding of current market dynamics. For investors and market enthusiasts seeking to comprehend why stocks may outpace economic indicators, this episode serves as an informative and thought-provoking resource.