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Is the equity market in “recession denial”? It seems like a crazy question to ask given that most markets are down this year – some evidence that many investors are concerned about the direction of the global economy.
Despite widespread fears about a recession this year, the stock prices of many cyclical businesses have experienced only modest drawdowns as of this writing. Amazingly, the stock prices of other companies (such as a large manufacturer of mining and construction equipment) are approaching all-time highs. Current consensus estimates for S&P 500 earnings call for 5% earnings growth in 2023. While this forecast has declined by a few percentage points over the past six months, positive earnings growth would still be quite an achievement in this environment and inconsistent with the slowdown US Federal Reserve (Fed) Chair Powell is trying to engineer.
In fact, if the S&P achieves the current consensus estimate in 2023, it will have delivered a compound annual earnings growth rate of 9% since 2019 (pre-COVID) – well above the long-term historical average and comfortably in the top quartile of rolling four-year periods over the last 50 years.
In a recent internal meeting, one of my fixed income colleagues commented that few of today’s market participants have lived through the type of tightening financial conditions the world is now in the midst of. In each prior instance of tightening of this magnitude, the global economy has experienced a significant slowdown. While each instance stands on its own and history is unlikely to perfectly repeat itself, I took that to mean we should be thinking about a wider distribution of potential outcomes for the economy (and, therefore, for markets as well). In the same meeting, two other colleagues highlighted the notable deterioration in some US economic indicators in just the last month.
Can the economy and markets really have enjoyed such a lengthy “party” since the 2008 global financial crisis, punctuated by a grand finale in 2020-2021, without suffering from any hangover at all? If corporate earnings were to materialize as described above, will inflation retreat to levels that are acceptable to the Fed? Current forecasts and asset prices seem to signal a belief that 2023 will not bring either materially higher interest rates or meaningfully lower earnings. I always tend to lean cautious, but this strikes me as an optimistic lens on the current set of circumstances.
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