The global stock market rally may be about to meet the reality of the recession

Skilled traders work inside a booth on the floor of the New York Stock Exchange (NYSE) in New York City, Nov. 10, 2022.

Brendan Mcdermid | Reuters

Global stock markets have rallied on hopes that central banks will soon begin slowing their aggressive interest rate hikes as inflation shows signs of peaking, but strategists are still not convinced the rebound has legs.

Markets were buoyant last week after US inflation fell below expectations for October, prompting investors to bet that Federal Reserve policymakers will soon have to slow or stop the monetary policy tightening measures they have implemented to try to reduce inflation. The S&P 500 posted its biggest single-day gain since the pandemic rebound rally in early 2020.

However, Fed Governor Chris Waller said on Monday that markets have overestimated the importance of a single data point and that the US central bank still has a “long way to go” on interest rate hikes.

Several analysts have echoed that sentiment in recent days. Black rock The Investment Institute said in a statement Monday that the labor constraints driving wage growth and underlying inflation may be more persistent than the market is pricing on.

While the rally in equities suggests that markets are reaffirming hopes for a soft landing from the Fed, BlackRock’s top strategists disagree and continue to underweight developed market equities.

“Stocks have jumped repeatedly this year in hopes that the Fed will come close to halting the fastest hike cycle since the 1980s, allowing the economy to enjoy a soft landing that avoids recession,” the chief said. of BlackRock Investment Institute Jean Boivin and his team.

“We think those hopes will be dashed again as the Fed presses ahead with excessive policy tightening. With the S&P 500 up 13% from its October low, stocks are even further away from the price of recession – and downgrade profits – which we see ahead”.

At the heart of the downside surprises expected from BlackRock are earnings downgrades. While the consensus expects earnings growth to fall from 10% in early 2022 to just over 4% in 2023, the world’s largest investment manager expects zero growth, noting that annual earnings growth by the third quarter would already be in negative territory without the huge windfall gains seen in the energy sector.

“We need to see stocks fall more, or more good news about easing inflation, to get positive on stocks,” Boivin’s team said.

Those sentiments were echoed on Wednesday by Dan Avigad, partner and portfolio manager at Lansdowne Partners, who told CNBC at the Sohn London Investment Conference that as central banks seek to suppress demand to tame inflation, so too do central banks’ profit margins. companies will have to shrink from their current “very high levels”.

“We’re still about 20% above the long-term trend in earnings if we look back at trends over decades, and so it seems to me quite likely that earnings trajectories are being overstated for the broader equity market, perhaps by up to at 15-20%,” Avigad said.

Bad eyesight

Wall Street’s rally on Thursday was the 15th largest one-day gain for the S&P 500 since the mid-1960s, according to Capital Economics. Senior markets economist Thomas Mathews said in a note on Monday that while there was a case at face value for further gains if falling inflation leads to an end to monetary tightening, the economic research firm still clung to a view pessimistic stocks amid risks to growth and earnings prospects.

Capital Economics forecasts a mild recession in the US and contractions in several major developed markets, a macroeconomic outcome that Mathews suggested hasn’t been fully priced into equity markets judging by consensus earnings expectations.

“Of course, US stock market valuation is now down significantly (as are stock market valuations elsewhere, but the experience of US recessions in the recent past is that the estimated price-earnings ratio of the S&P 500 has fallen quite a bit ahead of their inception, even though it was already low due to previous rate hikes and despite falling real safe asset yields,” Mathews said.

“All of this suggests that the sustainability of the latest rally depends at least as much on incoming data on economic growth and corporate profits as on inflation.”

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For now, however, Capital Economics sees earnings disappointing the market and further weighing on stocks, expecting the S&P 500 to fall to a low of 3,200 by mid-2023, about 20% below its current level, with other markets global equities down by similar amounts.

However, not everyone shares this view. Baird’s vice president of equities Patrick Spencer told CNBC that he had yet to see anything in the data to suggest a US recession and suggested that last week’s inflation data indicates the economy is looking at a “landing soft”. .”

“Stocks trade on earnings revisions and most of the dialogue is that we’re looking for a big recession in the US, and right now there isn’t,” Spencer said.

“Its earnings revisions and earnings still look okay, both in Europe and also in the UK given the valuation, and the US, so we would still make that argument.”

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