Worse-than-expected earnings reports from America’s largest publicly traded companies are set to become another “shock” for investors struggling to overcome fears of stagflation.
That’s the view of Thomas Mathews of Capital Economics, who says the S&P 500 index can easily bottom out at 3,750, and likely lower, on bad earnings news. On Thursday, the S&P 500 SPX,
ended down 0.6% at 3,900.79, a day after posting its biggest one-day decline since June 11, 2020. It missed falling below the 3,837.25 level that would have marked the technical definition of a bear market, according to Dow Jones Market Data.
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Wednesday’s sharp sell-off in stocks appeared to mark a shift in thinking in the markets as cracks appeared in the earnings results of major retailer Target Corp. TGT,
following a loss of profit from Walmart Inc. WMT,
the day before – a sign that rising inflation is seeping into almost every corner of the US economy. Over the past year, investors, traders and professional forecasters have all remained optimistic about an end to inflation. Markets have yet to price in the worst-case scenario for the economy, in which inflation does not decline and/or the United States slips into a recession, analysts said.
“The whole economy is affected by this robust inflation that we are seeing and I don’t see any type of resolution until equity prices start to reflect lower GDP and weaker income growth,” he said. said Tom di Galoma, a Treasury trader at Seaport Global. Holdings in Greenwich, Connecticut.
Although the S&P 500 is poised to enter a bear market, earnings forecasts remain positive, Capital Economics’ Mathews wrote in a note Thursday. Analysts expect near-double-digit earnings growth for companies in the index, on average, over the next two years, he said. And 12-month earnings forecasts for S&P 500 companies remain about 16% above their pre-pandemic trend, according to the market economist.
With the index falling 4% in a single day on Wednesday, “earnings are definitely a shock against the S&P 500,” Mathews wrote in an email to MarketWatch. “And earnings expectations still look very bullish, suggesting there’s a lot more potential ahead on that front.”
More bad earnings news could push the S&P 500 to 3,750, but even that could be too bullish, he said. In the event of a recession, it “would not be excluded” that the index would fall by 20% from here, based on historical experience.
Refinitiv’s S&P 500 Earnings Dashboard, released last Friday, shows there were 55 negative earnings-per-share announcements issued by S&P 500 companies for the second quarter. This compares to 28 who have tested positive.
Below is an overview of the risks facing the markets:
Inflation is at the top of the list of shocks currently going through the financial system.
One of the main reasons is that the United States – which recorded an annual headline rate of 8.3% in the April Consumer Price Index report, still near a 40-year high – may not have passed the peak of price gains. Disruptions to China’s zero-tolerance policy on COVID-19 and Russia’s war on Ukraine have yet to fully show up in the data, and traders expect another five months of more readings by 8%.
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“Fear of Growth”
Wednesday’s sharp sell-off in stocks – which sent the industrials Dow down 1,164.52 points and left the Dow, like the S&P 500, suffering its worst daily decline in nearly two years – had a distinctly different flavor to the past sales.
The final step down “had all the hallmarks of a growth scare,” Mathews wrote in his note. Bonds rallied as investors undid bets on rate hikes, safe-haven currencies strengthened and equities sold across the board.
By comparison, the factors behind most of the decline in stock prices this year were mostly linked to rising yields on “safe” assets as investors absorbed the Fed’s hawkish pivot, it said. -he declares.
As of this week, U.S. and eurozone stock markets appeared to price around a 70% chance of a near-term recession, based on an estimate by JPMorgan Chase & Co.’s Marko Kolanovic and others. . In their opinion, it is “too much risk of recession”.
Yet an underestimated risk is how quickly financial and economic conditions could deteriorate in the current environment. Seaport’s Di Galoma expects the United States to enter a recession in early 2023, although the time of arrival is “accelerating and coming much faster than people think”. “It’s right on our doorstep and I think this recession will be quite deep,” di Galoma said by phone Thursday.
Higher interest rates
The Federal Reserve is still poised to continue tightening financial conditions, with its balance sheet shrinking by nearly $9 trillion starting next month and policymakers expected to proceed with two more 50 basis point rate hikes. in June and July. Monetary policy alone is another “key shock,” although it’s been around for a while, and is weighing on earnings multiples, said Mathews of Capital Economics.
Investors have even tried to ignore the impact of rising rates, such as on May 4 when Fed Chairman Jerome Powell told reporters that a 75 basis point rate hike was not actively considered. Stock investors cheered the remark, but lost their enthusiasm the very next day – with the Dow Jones Industrial Average falling more than 1,000 points DJIA,
Russia, Ukraine and China
Russia’s war on Ukraine, which continues to rage after nearly three months, “still has the potential to cause significant volatility in commodity prices, which could affect the outlook for both earnings and monetary policy (boosting or slowing inflation),” Mathews said.
Moreover, the COVID-19 lockdowns in China are reverberating around the world, dampening global growth prospects and adding to inflationary pressures due to the Asian country’s role as a manufacturing powerhouse and source of many global goods.
“The confluence of events (inflation and the impact of policy responses to deal with it, war, China’s zero COVID policy and broader supply concerns) may mean that volatility persists in the near term as as we get more information on progress on each of them,” Andrew Patterson, senior international economist at The Vanguard Group, said in an email to MarketWatch.
Last week’s crash of the stablecoin TerraUSD raised fears in a few corners of the market that stablecoins as a whole could destabilize and trigger systemic risk.
This is the case even though Treasury Secretary Janet Yellen has tried to dispel the idea of a threat to financial stability, while acknowledging the risks. Regulators are worried and, at the very least, market participants may wonder if more idiosyncratic stablecoin runs are in store, if there are risks of contagion, and what the implications might be for broader money markets. wide.