Morgan Stanley warns: Non-farm data may directly determine the future trend of US stocks!

The Federal Reserve has successfully achieved what Morgan Stanley believed to be the best scenario before the interest rate decision, which is a significant rate cut. Now, whether the U.S. stock market can achieve their ideal performance in the fourth quarter depends on the labor market.

Before the Fed announced the rate cut last week, Morgan Stanley hoped to see a 50 basis point cut without causing concerns about unnecessary growth. In the end, their prediction came true, as the U.S. stock market hit a historic high on the second day of the Fed's rate cut announcement.

Now, Mike Wilson, Chief U.S. Equity Strategist at Morgan Stanley, outlined in a new research report the conditions needed for the fourth quarter to achieve a similar strong performance. He wrote:

"A decline in the unemployment rate and strong growth in non-farm payrolls (without downward revisions) may be the most favorable risk signals for the stock market in the fourth quarter. This development can offset seasonal weakness in earnings revisions and election-related volatility, both of which are important dynamics the market faces in the next month and a half."

The deterioration of the labor market is the main reason for the Fed's 50 basis point rate cut. By cutting rates significantly, the Fed is trying to avoid any potential labor-driven economic slowdown and ensure support for the economy.

The upcoming non-farm payroll data will measure its success. Morgan Stanley outlined three main possible outcomes for the September employment data to be released on October 4th:

The best scenario is for the unemployment rate to drop below 4.1% and non-farm payrolls to exceed 150,000. In this case, the market may see continued rotation, with funds flowing into cyclical stocks as investors are willing to take on more risk. Small-cap stocks, industrial stocks, consumer discretionary stocks, and real estate stocks will also benefit with future rate cuts.

The worst-case scenario is for the unemployment rate to rise above 4.3% and non-farm payrolls to drop below 100,000. This will lead the market to start shunning risk, with defensive stocks taking the lead.

Another possibility is for the employment report to remain at the current level. This mixed result does not have a clear risk level, but large-cap quality stocks may generally outperform other stocks.

Bank of America also emphasizes that before the election, the employment report is now the biggest market driver. Stock index options pricing indicates that the S&P 500 index will experience over 1% volatility on October 4th, regardless of the direction.

Of course, Morgan Stanley is not only concerned about the employment situation. They are also monitoring earnings revisions, manufacturing data, the World Economic Forum's Leading Economic Indicators, and employment trend indices.

Wilson wrote, "Ultimately, the Fed's rate cut beyond expectations can keep quality stocks at high prices for a longer period, and may even help provide some support for lower-quality stocks; however, labor and other growth data may need to improve now to prove that these conditions will persist until the end of the year."