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

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

Markets were supported last week after US inflation fell below expectations for October, prompting investors to bet that Federal Reserve policymakers will soon slow down or halt the monetary policy tightening measures they have been taking. deployed in an attempt to bring inflation down. The S&P500 recorded its biggest single-day gain since the rebound from the pandemic rebound in early 2020.

However, Fed Governor Chris Waller said on Monday that markets had overestimated the importance of a single data point and that the US central bank still had “some way to go” when it came to raising interest rates. ‘interest.

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

Although the surge in equities suggests markets are reaffirming hopes of a soft landing from the Fed, BlackRock’s top strategists disagree and remain underweight developed market equities.

“Stocks have jumped several times this year on hopes the Fed is nearing the end of the fastest rising cycle since the 1980s, leaving the economy to enjoy a soft landing that avoids recession. “said Jean Boivin, director of the BlackRock Investment Institute, and his team.

“We think those hopes will be dashed again as the Fed continues to over-tighten policy. With the S&P 500 jumping 13% from its October low, stocks are even further from prices. of the recession – and earnings downgrades – that we see going forward.”

At the heart of the downside surprises expected by BlackRock are downward earnings revisions. While consensus expects earnings growth to decline from 10% in early 2022 to just over 4% in 2023, the world’s largest investment manager expects zero growth, noting that Third-quarter annual earnings growth would already be in negative territory were it not for the huge windfalls seen in the energy sector.

“We need to see equities falling further, or more good news of easing inflation, to turn positive for equities,” 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 in order to keep inflation under control, corporate profit margins will also have to compress from their current “very high levels”.

“We’re still about 20% above the long-term earnings trend, if we look at trends for decades, and so it seems to me quite likely that earnings trajectories are overstated for the stock market. broadly, perhaps by as much as 15-20%,” Avigad said.

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Pessimistic view

Last Thursday’s Wall Street rally was the 15th biggest single-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 is a face value case for further gains if lower inflation leads to an end to monetary tightening, the economic research firm still clung to a pessimistic view of stocks amid risks to growth and earnings prospects.

Capital Economics expects a mild recession in the United States and contractions in several major developed markets, a macroeconomic outcome that Mathews said has not fully priced into equity markets judging by expectations. consensus on benefits.

“Granted, the valuation of the US stock market has now come down a lot (as have 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 by a a little further around their start, even though it was already low due to previous rate hikes and despite falling real yields on safe assets,” Mathews said.

“All of this suggests to us that the sustainability of the latest recovery depends at least as much on incoming data on economic growth and corporate earnings as it does on inflation.”

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

However, not everyone shares this view. Patrick Spencer, vice president of equities at Baird, told CNBC he hadn’t seen anything in the data yet to suggest a U.S. recession was on the cards, and suggested inflation data for the week latest indicate that the economy is contemplating a “soft landing”. .”

“Stocks are trading on earnings revisions and the majority of the dialogue is that we’re looking for a deep recession in the US, and that’s just not the case right now,” Spencer said.

“His earnings revisions and earnings still look decent, both in Europe and even in the UK given the valuation, and in the US, so we will still support that argument.”

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