The economy is doing well for now: Consumers are still spending, the labor market appears to be cooling slightly, and inflation is tiptoeing back from its multidecade highs. Yet August was a bad month for the stocks, and September isn’t any better. What gives?
The reality is that the U.S. economy can avoid a hard landing, and investors can still see stock prices fall.
That’s because U.S. stocks “are not priced anywhere close to recession and are actually pricing above-trend growth,” writes Bhanu Baweja, UBS chief strategist. In fact, at their current levels, prices imply 3.7% growth, ahead of the 3.5% long-term trend.
Yet if the economy does slow—even without a recession, as appears to be the case—then stocks would have to begin pricing in below-trend growth, “a process that would involve downward earnings revisions, and lower markets, without approaching/pricing a hard landing,” he notes.
In fact, a soft landing for the economy doesn’t exclude a hard landing for earnings, Baweja argues. Consensus estimates call for the
S&P 500 index
to notch earnings growth of 12%, a high level that would seem to require nominal gross domestic product growth of 5% to 6%, and margin expansion. That might be a tall order on both counts, he notes, as UBS is projecting nominal GDP growth of 2.4% in 2024, and if historical correlations hold that would imply margins are actually set to fall, to about 7% from 11%. That would imply negative earnings growth, even with ongoing economic expansion.
Then there’s the fact that while indicators are pointing to a soft landing, the S&P 500—still up by a double-digit percentage year to date, despite recent declines—is already trading at a “historically realistic level,” he writes.
In other words, investors aren’t wrong to be optimistic about the economy, but “recoveries have typically only turned into expansion when they are supported by monetary or fiscal policy.” Needless to say, the fact that the Federal Reserve’s strategy for a soft landing rests on real interest rates being higher for longer doesn’t support this case. Therefore, he expects leading indicators will at least pause, which would put downward pressure on the market as growth expectations stall.
All this points to the conclusion that while a hard landing would cause earnings to decline, it’s not necessary for them to do so.
“One could see lower earnings within the context of just weaker, non-recessionary growth,” Baweja writes.
Stifel Market Strategist Barry Bannister makes much the same point on Wednesday. Bannister, whose predictions have been fairly accurate this year, expects 2023 to end with a relative whimper, not a bang, for stocks, with the S&P 500 finishing at around 4,400—a gain of nearly 15%, but below an intraday high of 4,607.07 set in July.
He expects a hotter economy over the next three to six months, but doesn’t think that will fuel new highs for equities. By contrast he believes “that inflation will stabilize above the Fed’s chosen 2% price stability goal, keeping Fed policy ‘high for longer’ and financial conditions tight, the latter a constraint on equity valuation,” he notes.
That said, getting back to 4,400 would at least imply some relief from the market’s recent losses. Better late than never.
Write to Teresa Rivas at [email protected]
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