Financial markets are warning that a recession is imminent: here’s what it means for stocks

For much of this year, falling Treasury yields coincided with higher equity valuations as borrowing costs became an important concern for the market.

Now, it seems that this dynamic is changing, a sign that investors are beginning to prepare for an impending recession, even if the stock market has not fully embraced the view. this.

“Copper fell, oil prices fell despite the fact that inventory reports were lower than expected and China is reopening. Gene Goldman, chief investment officer at Cetera Investment Management, said the recession is weighing on everything.

Crude oil prices traded in the US
CL00,
+0.57%

fell 10.5% this week to $71.59 a barrel, according to FactSet data. And while copper prices have risen slightly during that time, they are still down more than 13% so far this year. The yield on the 10-year Treasury note has fallen about 25 basis points since early December.

So far this week, the S&P 500 is down 2.8% after a violent rally that began in mid-October. Steve Sosnick, chief investment strategist at Interactive Brokers, said the rallies Sharp but brief sentiments are not uncommon in bear markets.

So far, the stock is still surprisingly bullish even as expectations for corporate earnings growth in 2023 have softened.

Back in June, equity analysts had forecast earnings growth of 10.3% in 2023, according to median estimates from FactSet. As of December 7, expectations have dropped to just 5.9%. And some on Wall Street, including Michael Wilson of Morgan Stanley, expect earnings to fall in 2023.

But in the bond market, long-term bond yields fall, along with an increasingly inverted Treasury yield curve, sending a pretty strong signal that the market is counting on a recession next year.

“Expectations for a recession are growing and rightfully so. “We’re starting to see it priced in the market, which is not surprising after the rally we’ve had,” said Jake Jolly, senior investment strategist at BNY Mellon Investment Management. in the previous month.

There’s an old adage on Wall Street that the bond market is a more reliable guide to what’s going on with the U.S. economy.

“When stocks and bonds disagree about the economy, I tend to trust bonds more,” Sosnick said.

If this is true again, it means the stock is likely to fall in price.

“If you look at the S&P 500 at 3,930, that means next year earnings won’t drop. But during a recession, earnings typically drop by 10 to 15 percent,” said Ron Temple, head of US equities at Lazard Asset Management.

For now, at least, the US economy appears to be doing well despite the Federal Reserve raising its policy rate by about 4 percentage points this year.

The US labor market added 263,000 jobs in November, while US gross domestic product grew 2.9% in the third quarter. Even ISM barometer of service industry activity released earlier this week is above 55%, a level indicative of growth.

The bigger issue for the Federal Reserve is the fact that wages rose in the year to November to 5.1%, from 4.9% the previous month. Investors are worried that inflation will continue to increase if the economy does not cool down.

If both the economy and inflation stabilize, many on Wall Street expect the Fed to raise interest rates further, sending the economy into recession.

As of Thursday, Fed fund futures markets are predicting that the Fed’s benchmark policy rate will peak in March or May somewhere between 4.75% and 5.25%, before Fed to start cutting rates before year-end, according to CME’s FedWatch tool.

This implies that markets expect a sharp downturn to begin at some point before the middle of next year, Temple said. If that happens, there is likely to be more pain for the stock.

US stocks recovered somewhat on Thursday, with the S&P 500 up 0.7% to 3,961, while the Dow Jones Industrial Average
DIA,
+0.55%

rose 133 points, or 0.4%, to 33,732. Nasdaq Composite
COMPUTER,
+1.13%

up 1.2% to 11,085.