"Good News" Turns Into "Bad News": The More US Economic Data Beat Expectations, the More the S&P 500 Drops

The U.S. economy continues to exceed expectations, yet this has not provided new upward momentum for U.S. stocks.

Latest research from market research and asset management firm Leuthold Group has found that when economic data become strong enough, market focus often rapidly shifts from corporate profits and economic fundamentals to the outlook for Federal Reserve policy. The “good news is bad news” trading logic takes the lead—the stronger the economy, the harder it is for inflationary pressures to subside, giving the Federal Reserve less reason to relax policy, thus suppressing stock market valuations.

This pattern is repeating itself in the current market. Recently, U.S. employment, retail sales, and regional manufacturing data have all exceeded expectations. The Citigroup Economic Surprise Index (CESI) for the U.S. has remained above 50, at one point in June rising to 63—the highest level since 2023. However, U.S. stocks have not gained new upward momentum from economic resilience. Instead, they remain stuck in choppy trading, with investors recalibrating for “higher for longer” policy expectations.

According to Bloomberg, Leuthold’s statistics on data since 2003 show that when the Citigroup Economic Surprise Index rises above the strong range of 40, the S&P 500 is very likely to post a negative return over the following three weeks, on average requiring about three months to recover losses. As U.S. stock valuations remain at elevated levels and the market becomes increasingly sensitive to Federal Reserve policy, the impact of economic data is undergoing subtle changes.

Historical data shows: "The stronger the economy, the more likely the stock market adjusts"

Leuthold analyzed the historical performance of the Citigroup Economic Surprise Index and the S&P 500.

Research indicates that since the index was launched by Citigroup in 2003, there have been 28 instances where the Economic Surprise Index climbed above 40, with the S&P 500 recording a negative return over the following 21 trading days in those cases, on average needing about three months to make up the decline. Currently, the Citigroup Economic Surprise Index stands at 50.3, well above the key level of 40, meaning the U.S. economy overall continues to consistently outperform market expectations.

Chun Wang, Head of Multi-Asset Strategy at Leuthold, stated that over the past two to three months, the “good news is bad news” logic has been particularly apparent. However, he also pointed out that the biggest difference this cycle versus history is the disruption from the Middle East situation. The U.S.-Iran conflict has driven up oil prices and break-even inflation, adding extra noise to the market and making investors more sensitive to inflation and the policy path.

Federal Reserve expectations become the market’s core variable

Consistent economic upside surprises mean the Federal Reserve may face increased difficulty in achieving its 2% inflation target and prompt the market to re-adjust future interest rate expectations.

Explosive Options founder and Chief Strategist Bob Lang said, “Monetary policy could see new changes next week and later this fall, reflecting the possibility that decision-makers may adopt an even more hawkish stance against inflation.”

Sameer Samana, Head of Global Equities and Real Assets at Wells Fargo Investment Institute, believes that the recent weakness in the S&P 500 is not solely driven by economic data; the sector rotation within tech stocks and the AI sector has also played an important role.

However, he also notes that some investors do indeed view consistently strong economic data as a reason for the Federal Reserve to maintain higher rates or even further tighten policy.

High valuations amplify the “good news becomes bad news” effect

Changes in the market environment are also closely related to valuation levels. Since the end of March, the S&P 500 has risen about 17% cumulatively, meaning a lot of optimistic expectations are already priced in. Against this backdrop, new economic positives are no longer able to further boost valuations and instead more easily trigger investor concerns about tighter policy.

Ken Mahoney, CEO of Mahoney Asset Management, said, “The most ideal economic scenario may already be fully priced in by the market. Now, solid economic data have instead become a source of pressure for the stock market, and the way the market interprets news has shifted asymmetrically.”

As for the outlook, Chun Wang advises investors to maintain a relatively balanced risk allocation. He says the current market environment “is not bad enough to require extreme pessimism,” but the mix of geopolitics, inflation expectations, and monetary policy makes today’s market even more complex than historical experience suggests.

He concluded: “Today, the stock market itself has become a component of the economy. The greatest risk to the economy stems from the possibility of a reversal in the stock market wealth effect. Therefore, when it comes to asset allocation and exposure to risk assets, it remains more appropriate to maintain a neutral stance.”