2023-07-21 07:11:42 ET
Equity investors look increasingly confident that the recession that everyone was expecting will not materialize as stock valuations keep climbing.
In the July BofA Fund Manager Survey, 68% are now in the soft landing camp for the global economy (even though they see slowing growth), while just 21% expect a hard landing.
"Wall Street forecasters are busy reducing recession probabilities, seemingly willing to bet the farm on an outcome that is literally never happened in history: a soft landing despite a historically deep and sustained yield curve inversion and concomitant collapse in the monetary aggregates," Roth MKM strategist Michael Darda wrote in a note.
"We have been in the disinflation camp since last summer (after having been in the inflation/Fed behind-the-curve camp prior)," Darda said. "However, a disinflation brought about by the policy rate exceeding the neutral rate is one in which a recession is highly likely."
"Once the yield curve inverts and real money growth collapses, we have essentially crossed the recession Rubicon."
Too quick to throw in the towel
"Investors seem to be giving up on what has been the most widely anticipated recession in history," SocGen strategist Albert Edwards wrote.
"Now just because something is universally expected doesn’t mean it will necessarily come to pass," Edwards said. "But what it does mean is that that forecast is likely to be ‘in the price’. So anything that comes along to undermine that view will likely engender an outsized reaction in the other direction. This is what has happened."
Bull/Bear charts show "that a year back investors were more bearish than even in the depths of the 2008 Global Financial Crisis, which was bizarre," he added. "Hence, as the saying goes, 'when everyone is bearish, who is left to sell? The over-anticipation of an imminent recession last year helps account for the snap back in equities this year."
But "one thing is clear – economists having apparently gottheir recession call wrong, always give up on it just at the point when it arrives," Edwards said. Indeed, I can remember even I, an uber bear, finding myself doubting my own recession forecast as we went through 2007. But I’ve seen this show before, and I’m not wavering now."
The '50s and now
"The inflation of the early 1950s was driven by a war-driven jump in money velocity rather than a surge in the money stock," Darda said. "As the Fed wrestled its independence away from the Treasury and cemented its credibility, inflation came down rapidly. Yet, there was no collapse in base or broad money (nominally), no massive, sustained inversion in the yield curve, and hence no recession."
"The S&P 500 ( SP500 ) ( NYSEARCA: SPY ) ( IVV ) ( VOO ) appears to be keying off the early 1950s disinflation but equity valuations are MUCH higher today meaning the failure of a soft landing to materialize could serve risk markets with a serious setback." (Emphasis added.)
"Equity markets performed well during the 1951-1952 disinflation with the S&P 500 rising about 27% from April 1951 when CPI inflation peaked at 9.6% to December 1952 when it fell below 1%," Darda noted. "The S&P 500 is up 24% from the June lows (the month CPI inflation peaked above 9% y/y) and up 27% from the October lows. Yet, we are closing in on a 20x forward multiple for the S&P 500 with the equity risk premium at a new cycle low of 1.25%."
"The 1951-1952 rally was driven by a more than 20% rise in earnings with the market still at the equivalent of a the October lows has been a pure valuation play as earnings estimates are actually a few dollars below where they were last fall. There simply is no comparison, although markets clearly think there is."
"We continue to favor long positions across the Treasury curve ( SHY ) ( IEI ) ( TBT ) ( TLT ) and non-expensive, non-cyclical equity sectors that have underperformed YTD (healthcare) ( XLV )," he said. "With its underperformance since last year, energy ( XLE ) has risen to the top of our sector ranking model. However, there is potential downside across all cyclical sectors, but likely far less than in those areas that have led the YTD advance."
"As of this writing, the S&P 500 info tech index ( XLK ) is back above a 28x forward multiple, a valuation level last seen in late 2021 just before a more than 30% collapse for the sector. The info tech sector also has the dishonorable distinction of carrying a negative equity risk premium (earnings yield below the prevailing bond yield) for the first time since the summer of 2007. There were still some gains ahead back then, but not for long."
More on the soft landing
- Stick The Soft Landing
- UBS says stocks look too optimistic after the Fed minutes and the idea of a soft landing
For further details see:
Are stock bulls betting too much on the Fed engineering a soft landing?