The global stock market rally may face the reality of recession

Expert traders work inside a post on the floor of the New York Stock Exchange (NYSE), Nov. 10, 2022.

Brendan McDermid | Reuters

Global stock markets have been buoyed by hopes that central banks will soon begin to slow aggressive rate hikes as inflation shows signs of peaking, but strategists are not yet convinced that the slowdown has legs.

Markets rallied last week after U.S. inflation came in below expectations for October, prompting investors to believe that Federal Reserve policymakers will soon have to slow or stop their monetary tightening measures to lower inflation. The S&P 500 It posted its biggest one-day gain since the pandemic rebound rally in early 2020.

However, Fed Governor Chris Waller said on Monday that markets were overestimating the significance of a single data point and that the US central bank still had “a ways to go” on rate hikes.

Several analysts have echoed this sentiment in recent days. BlackRock The investment institute said in a note on Monday that labor constraints, which are driving wage growth and core inflation, may be more durable than the market price.

While rising stocks showed markets were confirming hopes of a soft easing from the Fed, BlackRock’s top strategists disagreed and remain underweight developed market stocks.

“Stocks have rallied this year on hopes that the Fed will come close to ending its fastest hiking cycle since the 1980s and that the economy will enjoy a mild recession-preventing recession,” said Jean Boivin, head of BlackRock Investment Institute and his team.

“We think those hopes will be dashed again as the Fed moves forward with excessive tightening. With the S&P 500 jumping 13% from its October lows, stocks are further priced out of the recession — and earnings cuts — we see ahead.”

At the heart of BlackRock’s expected downside surprises is an earnings cut. While the consensus expects earnings growth to fall from 10% in early 2022 to 4% in 2023, the world’s largest investment manager expects zero growth, noting that annual earnings growth will already be in negative territory in the third quarter without major expectations. observed in the energy sector.

“We need to see more declines in stocks or more good news about lower inflation to be positive on stocks,” Boivin’s team said.

Those sentiments were echoed by Dan Avigad, partner and portfolio manager at Lansdowne Partners, who told CNBC on Wednesday at the Sohn London Investment Conference that corporate profit margins will have to be squeezed as central banks try to suppress demand to tame inflation. their current “very high levels”.

“Looking at decades of trends, we’re still about 20% above the long-term trend in terms of earnings, and so I think earnings trajectories are probably overestimated for the broader stock market. By 15-20%,” Avigad said.

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Poor appearance

Last Thursday’s Wall Street rally was the 15th biggest one-day gain for the S&P 500 since the mid-1960s, according to Capital Economics. While there is a nominal case for more gains if lower inflation leads to an end to monetary tightening, the economic research firm still maintains a bearish outlook on stocks amid downside risks, senior economist Thomas Matthews said on Monday. growth and profit forecast.

Capital Economics expects a moderate recession in the US and a contraction in several key developed markets, a macroeconomic result suggested by Mathews that was not fully discounted in equity markets, based on consensus earnings expectations.

“Admittedly, US stock market valuations are now down considerably (as are stock market valuations elsewhere), but the experience of recent US recessions is that the price/earnings ratio of the S&P 500 has fallen slightly. growth and the decline in real safe-asset returns, it’s moved a little further around their start, even if it’s already low,” Mathews said.

“All of this suggests that the durability of the recent rally depends at least as much on incoming data on economic growth and corporate earnings as it does on inflation.”

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Currently, Capital Economics sees earnings disappointing the market and further weighing on stocks, forecasting the S&P 500 to fall to 3,200 by mid-2023, about 20% below its current level as other global equity markets fall. similar amounts.

But not everyone shares this opinion. Patrick Spencer, Baird’s vice chairman of equities, told CNBC he has yet to see anything in the data to suggest a U.S. recession is on the cards, adding that last week’s inflation data showed the economy was looking at a “softer downturn.” .”

“Equities are trading earnings revisions and most of the dialogue is that we’re looking for a sharp recession in the U.S. and that’s not happening right now,” Spencer said.

“Its earnings revision and earnings still look good in both Europe and the UK and the US, so we’ll still stand by that argument.”

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