Wall St Week Ahead: Recession? Soft landing? Stagflation? Investors assess the strength of the economy

The floor of the New York Stock Exchange (NYSE) is seen after the close of trading in New York, U.S., March 18, 2020. REUTERS/Lucas Jackson/File Photo

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NEW YORK, July 8 (Reuters) – With a miserable first half for the stock market now in the history books, investors are weighing whether the U.S. economy can avoid a major slowdown as the Federal Reserve raises rates to fight against the worst inflation in decades.

The answer to this question should have a direct impact on the markets. Strategists say an economic slowdown coupled with weak corporate earnings could drag the S&P 500 (.SPX) down at least another 10%, deepening losses that have already sent the benchmark down 18% since the beginning of the year.

Conversely, in a scenario that includes solid earnings increases and moderating inflation, equities could rebound to around their start-of-year level, according to some analysts’ price targets.

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For now, “investors are anticipating that we are seeing a slowdown,” said Lindsey Bell, head of markets and currency strategist at Ally. “The big question is, how big will this downturn be?”

Arguments for an impending economic downturn took a hit on Friday, after a Labor Department report showed employers hired far more workers than expected in June, giving the Fed ammunition for a new interest rate hike of 75 basis points this month. Read more

“The June jobs report indicates that the economy is neither on the verge of a recession – let alone already in a recession – nor in a state of overheating,” Oxford Economics said in a note.

He predicted greater market volatility “amid heightened speculation about what the Fed will do.”

More key information on how the economy is developing is expected later this month as second-quarter earnings reports pour in over the coming weeks and investors analyze new data, including the Wednesday’s closely watched consumer price report for June.

Although the Fed has said it is confident of achieving a so-called soft landing by bringing inflation down without disrupting the economy, some investors believe the sharp declines in equities this year suggest that some economic slowdown is already priced into asset prices.

The S&P 500 (.SPX), for example, fell 23.6% from its all-time high in January this year, in line with the median 24% drop the index has seen in past recessions, indicating that “At least some of the challenging environment is reflected in stock prices,” Keith Lerner, co-chief investment officer at Truist Advisory Services, said in a report.

Recessions are officially called retrospectively, with the National Bureau of Economic Research declaring one when there has been “a significant decline in economic activity that spans the entire economy and lasts for more than a few months “. Read more

COMPETING SCENARIOS

Forecasts vary as to how difficult the economy may become.

A note outlining various economic scenarios from UBS Global Wealth Management says the S&P 500 could fall to 3,300 – about 31% from its January peak – if an economic crisis leads to a sharp decline in corporate earnings, as well as in the event of stagflation. “, which typically involves a cocktail of consistently high inflation combined with slow growth.

The bank’s analysts gave a 30% chance for the “crisis” scenario and pegged the stagflation chance at 20%.

A “soft landing” scenario is their most likely outcome, however, and would include the S&P 500 ending the year at 3,900 – just around its Friday close. Read more

Such a scenario, to which UBS assigned a 40% weighting, hinges on investors’ belief that inflation is under control and earnings can remain resilient despite tighter financial conditions, they said.

In a recent note describing the “increasing likelihood of a stagflationary environment,” strategists at BofA Global Research recommended investors combine areas of the stock market that would benefit from inflation, such as energy, with defensive sectors like health.

Strategists at the Wells Fargo Investment Institute, meanwhile, earlier this week called for a “moderate U.S. recession” and lowered their year-end S&P 500 target to a range of 3,800 to 4,000.

Some investors have a more optimistic view of the economy and think stocks could rise from current levels.

Citi strategists weighted a “soft landing” scenario at 55%, though they also saw a 40% chance of a mild recession and 5% chance of a severe one. Their end-of-year S&P target is 4,200.

John Stoltzfus, chief investment strategist at Oppenheimer Asset Management, lowered his S&P 500 price target this week to 4,800 from the 5,330 he initiated in December – with the new level still 23% above the level where the index closed on Friday.

He expects consumer demand, business investment and government spending to support growth.

“It’s a resilient economy,” Stoltzfus said.

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Reporting by Lewis Krauskopf in New York Editing by Ira Iosebashvili and Matthew Lewis

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