Investors are worried the stock market could face an earnings recession that could potentially lead to deeper losses after the S&P 500 index just endured its worst week since March 2020.
“It’s pretty clear that earnings estimates are likely to come down after rising since the beginning of the year,” said Bob Doll, chief investment officer at Crossmark Global Investments, in a phone interview. “That’s why the market is nervous,” he said, while investors wondered how “bad” earnings could get in a slowing economy as the Federal Reserve scrambles to curb rising inflation.
The Fed has become more aggressive in its fight against inflation after rising to its highest level since 1981 in May, fueling fears that the central bank could create a recession by destroying demand with rate hikes to cool the economy .
According to Doll, stock valuations have already fallen this year as stocks have been too expensive compared to high inflation and interest rates no longer close to zero. He said stocks remain under pressure as the room for the Fed to embark on a soft landing for the US economy appears to be narrowing amid mounting concerns over slowing economic growth and the still stubbornly high cost of living.
“People are concerned that the Fed will have to hike so much that it would push the economy into recession,” said Luke Tilley, Wilmington Trust’s chief economist, in a phone interview. “They’re not trying to create a recession,” he said, but they would create one if needed to prevent long-term inflation expectations from “getting off the hook” and “getting out of control.”
Whatever the odds of a “soft landing” before Consumer price index report June 10 showed higher-than-expected inflation in May, “they’re smaller now,” Doll said. That’s because the report prompted the Fed, which is behind the curve, to tighten monetary policy more aggressively, he said.
The Fed announced on June 15 that it was raising its benchmark interest rate by three-quarters of a percentage point – the largest increase since 1994 – to a target range of 1.5% to 1.75% to combat unexpected increases in the cost of living.
That’s well below the 8.6% inflation rate measured by the CPI over the 12 months to May, with last month’s increase in the cost of living being driven by increases in energy and food prices and higher rents.
In recent quarters, companies in the US have been successful in raising prices to keep up with their own cost pressures on labor, materials and transportation, Doll said. But eventually the consumer takes a pass and says, “‘I’m not paying for that thing anymore.'”
Accordingly, US retail sales fell in May for the first time in five months a report by the US Department of Commerce on June 15. This is the same day the Fed announced its rate hike, prompting Fed Chair Jerome Powell to hold a press conference on the central bank’s monetary policy decision.
“Markets should brace for both weaker growth and higher inflation than the Fed is willing to admit,” Bank of America economists said in a June 16 BofA Global Research report. “Chairman Powell described the economy as still ‘strong’. This is certainly true for the labor market, but we are seeing very weak GDP growth.”
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BofA economists said they now expect “only a 1.5% rebound” in gross domestic product in the second quarter after GDP fell 1.4% in the first three months of the year. “The weakness is not broad enough or persistent enough to be indicative of a recession, but it is worrying,” they wrote.
Stocks, CEO Confidence Decline
The US stock market is down this year with the S&P 500 index SPX,
and tech-heavy Nasdaq Composite COMP,
Slide into a bear market. The Dow Jones Industrial Average DJIA,
is approaching bear market territory, which it would enter with a close at least 20% below its 2022 peak in early January.
According to Dow Jones Market Data, the Dow ended Friday with its biggest weekly percentage drop since October 2020. The S&P 500 had its worst week since March 2020, when stocks tumbled amid the COVID-19 crisis.
Selling pressure in the market has been “so extraordinarily intense” that the possibility of a sharp reversal is “always present,” if only as a “countertrend rally,” James Solloway, chief market strategist at SEI Investments Co., said in a phone interview.
Meanwhile, CEO confidence has plummeted.
“The Conference Board Measure of CEO Confidence recently suffered one of the steepest consecutive falls in decades,” said Lisa Shalett, chief investment officer of Morgan Stanley’s wealth management business, in a June 13 note. It slumped towards 40, “a level that has historically coincided with earnings recessions or negative year-on-year earnings changes.”
The loss of confidence is “at odds” with the current trend of analysts’ bottom-up earnings estimates, which have moved higher since January and imply 13.5% year-on-year growth in 2022, Shalett said in the note. It seems unlikely that companies will be able to sustain “record high operating profit margins” amid slowing GDP growth, she said.
A new survey The study, released Friday by the Conference Board, found that more than 60% of global CEOs expect their region to experience a recession before the end of 2023, with 15% of chief executives saying their region is already in recession.
According to Yardeni Research, the probability of a US recession is “high” at 45%.
Read: “The economy will collapse,” says Wall Street veteran Novogratz. “We’re going to go into a really quick recession.”
“As industry analysts trim their 2022 and 2023 profit margin estimates, expected profit margin rose to a record high last week,” Yardeni Research wrote in a June 16 note. “Some sectors are starting to be pulled down by gravity: namely communications services, consumer discretionary and consumer staples, while the others are still buoyant.”
Crossmark’s Doll said an economic recession could pull the S&P 500 below 3,600 and that the stock market is facing increased volatility as it lacks the end of the Fed’s rate-hiking cycle. The likelihood of a recession has risen “a fair bit” after May’s inflation readings, he said.
Next week investors will see new US economic data on home sales and jobless claims, as well as readings on US manufacturing and services activity.
“The window for a soft landing is actually getting tighter,” Solloway said. “The question is how long it’s going to be before a recession hits,” he said, saying his expectation was “it’s going to be a while,” maybe at least a year to 18 months.
https://www.marketwatch.com/story/why-stock-market-investors-are-nervous-that-an-earnings-recession-may-be-looming-11655548403?rss=1&siteid=rss Why stock market investors are “nervous” that an earnings recession is looming