Some of Wall Street’s heavyweights are pouring cold water on expectations that the U.S. economy will scrape through 2023 without a recession, even as hopes of resilient growth and easing inflation drive stocks higher.
Banks and asset managers that have restated recession calls include Wells Fargo, BlackRock, and Neuberger Berman, with the majority warning the Federal Reserve is unlikely to push inflation lower without weakening economic growth.
The warnings conflict with signs of optimism in markets. The S&P 500 has surged more than 4% so far this year, triggered in part by bets that inflation will continue to ease, allowing the Fed to soon fall back from the rate hikes that shook markets in 2022. The tech-heavy Nasdaq 100 has jumped more than 7%.
“Money is dying to get back into this market but we still think you get an economic slowdown and that earnings expectations are still too high,” said Paul Christopher, head of global investment strategy at the Wells Fargo Investment Institute.
Correctly assessing the economy is critical for investors. Stocks are likely to perform poorly in economic downturns, with the S&P 500 losing an average of 29% during recessions since World War Two, according to Truist Advisory Services.
While recessions are labeled in hindsight, investors have said that still-resilient job growth makes it unlikely that one has already begun.
Many strategists are directing attention to the Fed, pointing to years of market history that signals the central bank’s rapid rate increases will eventually drive unemployment higher and steer the economy into a recession.
The Fed last year hiked its benchmark rate to between 4.25% and 4.50% from zero and is broadly expected to raise it by another 25 basis points at the end of its Feb. 1 meeting.
Policymakers have predicted their key policy rate would peak between 5.00% and 5.25% in 2023. Market pricing suggests investors are taking a more dovish view, with the rate peaking below 5% around mid-June before dropping in the back half of the year.
The latter stance is not shared by BoFA’s strategists, who advocated for positions that would benefit from a “grind lower” in U.S. equities, noting that Fed “cutting cycles in history have almost gain been associated with either a recession … or a financial accident,” they said.
Charlie McElligott, managing director of cross-asset strategy of Nomura Securities, thinks the current jump in stocks is partially caused by under-positioned investors fearful of missing a longer-term shift to the upside, a dynamic that sparked several rallies in 2022.
Those rebounds undoubtedly tumbled, leaving the S&P 500 with a 19.4% annual loss, its worst since 2008. The most recent rebound has raised the S&P 500 more than 11% from its October lows.
“You are now getting the disinflationary impulse that the Fed has been seeking and it’s moving ahead of schedule,” he said. “Now the challenge is that people are under-positioned and are … absolutely being forced into a painful trade because the Fed hasn’t won the fight yet.”
The current stock rally “hints at how markets will likely react once inflation eases and rate hikes pause,” wrote analysts at BlackRock, the world’s biggest asset manager, earlier this week. “Before this outlook becomes reality, we see (developed market) stocks falling when recessions we expect to manifest.”
Neuberger Berman sees the S&P 500 falling to as low as 3,000 in 2023 – a drop of about 25% from its current level – as rebounding inflation pushes the Fed to become more aggressive.
“You need that kind of decline in stock prices to neutralize the wealth effect that is the source of inflation,” said Raheel Siddiqui, a senior research analyst in the firm’s global equity research division.
Of course, many investors are doubtful of banks’ forecasts.
Burns McKinney, a portfolio manager at NFJ Investment Group, observed that the majority of the banks failed to predict the inflationary surge that pushed the Fed to jack up rates. Strategists surveyed by Reuters at the end of 2021 saw the S&P 500 jumping by a median of 7.5% last year.
McKinney expects any recession to be a shallow one, and is going into industrial stocks and technology companies that are poised to gain from easing inflation.
“Stocks aren’t terribly cheap and they are not terribly expensive either,” he said. “There’s a lot of ways to describe Goldilocks but the market is priced just about right.”
