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

Specialist traders work inside a post on the floor of the New York Stock Exchange (NYSE) in New York City, November 10, 2022.

Brendan McDermid | Reuters

The global stock market has rallied on hopes that the central bank will soon begin to slow down their aggressive interest rate hikes as inflation shows signs of peaking, but strategists are not yet sure that the boom will have legs.

The market was buoyed last week after US inflation came in below expectations for October, encouraging investors to bet that Federal Reserve policymakers will soon have to slow down or stop the monetary policy tightening measures they have deployed to try to bring down inflation. The S&P 500 made the biggest one-day profit since the early 2020 pandemic rebound rally.

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

Several analysts have echoed that sentiment in recent days. BlackRock The investment institution said in a note Monday that labor constraints driving wage growth and core inflation may be more persistent than market prices.

Although surging stocks suggest the market reaffirms the hope of a soft landing from the Fed, BlackRock’s top strategists disagreed, and still underweight developed market stocks.

“Equities have jumped several times this year in hopes that the Fed may be getting closer to stopping the fastest hiking cycle since the 1980s, letting the economy enjoy a soft landing that avoids recession,” said Head of BlackRock Investment Institute Jean Boivin and his team.

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“We think their hopes will be dashed again as the Fed pushes forward with overtightening policies. With the S & P 500 jumping 13% from its October low, the stock is even further from the price in recession – and earnings downgrades – we see ahead.”

Central to the surprise down is expected by BlackRock’s earnings downgrades. While consensus expects earnings growth to fall from 10% in early 2022 to more than 4% in 2023, the world’s largest investment manager expects zero growth, saying third-quarter annualized earnings growth is already in negative territory without significant headwinds. seen in the energy sector.

“We need to see stocks drop more, or more good news to ease inflation, to be positive on stocks,” said Boivin’s team.

This sentiment was echoed Wednesday by Dan Avigad, partner and portfolio manager at Lansdowne Mitra, who told CNBC at the Sohn London Investment Conference that as the central bank looks to reduce demand in order to tame inflation, corporate profit margins must also cool down. they are now “very elevated level”.

“We are still running about 20% above the long-term trend in terms of earnings, if we look back at the trend over the decades, and it seems to me that the earnings trajectory now estimated for the larger stock market is probably by 15-20%,” Avigad said.

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Downbeat performance

Last Thursday’s Wall Street rally it was the 15th-largest single daily 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 although there is a case at face value for further gains if falling inflation leads to an end to monetary tightening, the economic research firm is sticking to its view of equities amid risks. growth outlook and earnings.

Capital Economy expects a mild recession in the US and contraction across several major developed markets, the macroeconomic results that Mathews suggested have not been fully discounted in the equity market judging by consensus earnings expectations.

“Admittedly, the valuation of the US stock market has now fallen significantly (like the valuation of the stock market elsewhere, but the experience of the US recession in the past is that the ratio of price / estimated earnings of the S&P 500 fell a. bit further around their beginning, although it was already low due to the increase in the previous rate and despite the fall in the yield of real safe assets, “said Mathews.

“All this shows us that the sustainability of the recent rally depends at least as much on the data coming in on economic growth and corporate profits as it does on inflation.”

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For now, though, Capital Economy sees the market’s disappointing earnings and further weight in stocks, forecasting that the S&P 500 will fall to a trough of 3,200 by the middle of 2023, around 20% below its current level, with other global equity markets declining by. similar amount.

Not everyone shares this view, however. Patrick Spencer, vice chairman of equities at Baird, told CNBC that he had yet to see anything in the data that suggested a US recession was on the cards, and suggested that last week’s inflation data showed that the economy has seen a “soft landing”. .”

“Equities trading on earnings revisions and the majority of dialogue is that we are looking for a steep recession in the US, and it’s just not there at the moment,” said Spencer.

“Revised earnings and earnings still look okay, both in Europe, even in England given the valuation, and the US, so we will still stand behind that argument.”

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