A stock market paradox, in which bad news about the economy is seen as good news for stocks, may have played out. If so, investors should expect bad news to be bad news for stocks heading into the new year – and there could be plenty of bad news.
But first, why is good news bad news? Investors have spent most of 2022 focusing on the Federal Reserve and its series of rapid rate hikes aimed at curbing inflation. Economic news showing slower growth and less fuel for inflation could help lift stocks on the idea that the Fed could start to slow down or even start cutting interest rates in the future.
On the contrary, good news about the economy maybe bad news for stocks.
So what has changed? Last week saw November consumer price index lower than expected. While it’s still hot, with prices up more than 7% year-over-year, investors are increasingly confident that inflation could hit a nearly four-decade peak above 9% by June.
See: Why November CPI data is considered a ‘game changer’ for financial markets
But the Federal Reserve and other major central banks have indicated they intend to continue raising interest rates, albeit at a slower pace, into 2023 and potentially keeping them high for longer than they would otherwise. investors’ predictions. That raised fears that a recession is becoming more likely.
Meanwhile, markets are behaving as if the worst of inflation fears have passed, with recession fears now looming, said Jim Baird, chief investment officer at Plante Moran Financial Advisors.
In a phone interview, Baird said that sentiment was bolstered by Wednesday’s manufacturing data and weaker-than-expected retail sales on Thursday.
“Markets are probably going back to a period where bad news is just bad news not because interest rates will worry investors, but because earnings growth will slow down,” Baird said.
A ‘reverse Tepper transaction’
Keith Lerner, co-chief investment officer at Truist, argues that a mirror image of the scene creates what is known as a “Tepper trade,” inspired by hedge fund giant David Tepper in September 2005. 2010, may be taking shape.
Unfortunately, while Tepper’s pre-emptive call is for a “win/win scenario”. Lerner said the “reverse Tepper trade” is forming as a lose/lose proposition.
Tepper’s argument is that the economy will get better, which will benefit stocks and asset prices. Or, the economy will weaken, with the Fed intervening to support the market, which will also have a positive effect on asset prices.
The current setup is one where the economy will weaken, curbing inflation but also dent corporate profits and challenge asset prices, Lerner said. Or, alternatively, the economy remains strong, along with inflation, with the Fed and other central banks Continue to tighten policyand challenge asset prices.
“In either case, there is a potential headwind for investors. To be fair, there is a third path whereby inflation falls and the economy avoids a recession, aka a soft landing. It is possible,” wrote Lerner, but noted that the path to soft landing was narrowing.
Recession worries were on show on Thursday, as November retail sales down 0.6%, beating forecasts for a 0.3% drop and the biggest drop in nearly a year. Additionally, the Philadelphia Fed’s manufacturing index rose, but remained negative, disappointing expectations, while the New York Fed’s Empire State index fell.
Stocks, which had suffered moderate losses after the Fed raised interest rates by half a percentage point a day earlier, fell sharply. Stocks extend Friday’s decline, with S&P 500
SPX,
recorded a weekly loss of 2.1%, while the Dow Jones Industrial Average
DIA,
down 1.7% and Nasdaq Composite
CALCULATOR,
down 2.7%.
Read: Still a bear market: S&P 500 drop signals stocks never reached ‘escape speed’
“As we move into 2023, economic data will have more of an impact on stocks as the data will tell us the answer to a very important question: How bad will the recession be? any? That’s the key question as we start the new year, because with the Fed’s relative policy of ‘autopilot’ (more rate hikes to start in 2023), the key now is to raise rates. growth and potential damage from slowing growth,” Tom Essaye, founder of Sevens Report Research, in a Friday note.
recession clock
No one can say with absolute certainty that a recession will hit in 2023, but it seems certain that corporate earnings will come under pressure and that will be the main driver for the market, Baird of Plante Moran said. And that means earnings are likely to become a source of significant volatility next year.
“If in 2022 the story is inflation and interest rates, by 2023 it will be earnings and recession risk,” he said.
“This is no longer an environment in favor of high-risk, high-growth stocks, while cyclical factors could set up a good base for value-driven and small-cap stocks,” he said.
Truist’s Lerner says that until the weight of the evidence shifts, “we will maintain an excessive weighting on fixed income, where we focus on high-quality bonds and a relatively low weight on with stocks.”
In equities, Truist favors the U.S., favors value, and sees “better opportunities below the surface,” such as the equally weighted S&P 500, a proxy for stocks. medium.
Highlights of economic calendar for next week includes a revised look at third-quarter gross domestic product on Thursday, along with the November readings of leading economic indicators. On Friday, November personal spending and consumption data, including the Fed’s preferred inflation gauge, will be released.
