- Stocks are up more than 6% year-to-date and 14% since October.
- According to Bob Doll, investors are ignoring recession signals.
- Doll says the S&P 500 will drop to 3,400 if a mild recession unfolds.
But strong labor-market data and a less-hawkish Federal Reserve are distracting investors from that pain that’s due to come, he said.
“Into the high — which is not that long ago, a week or so ago — the talk was all about the economy: ‘It’s going to be ok, maybe we’ll have a soft landing, the Fed’s almost done, inflation’s coming down, I guess I should buy some stocks,'” Doll told Insider on Friday. But the slew of recession harbingers still flashing warning signs is “not talked about at all,” he added.
Take the yield curve, he said, which is at its most inverted level in more than four decades. Shorter-term bond yields rising higher than longer-term yields reflects tight monetary policy and low investor confidence in the economy’s near-term prospects. The curve has inverted before every recession since the 1960s.
Then there’s manufacturing activity, Doll said, which is down in many major economies across the world including the US, the UK, the Eurozone, and Brazil.
Encompassing both of these indicators in addition to several others — like consumer sentiment and stock performance — the Conference Board’s Leading Economic Index is now in recessionary territory.
Money supply growth is negative for the first time since the Fed started tracking data on it in the 1950s, Doll pointed out.
Credit standards are also tightening, he said.
“According to the senior loan officers survey, the percentage of banks becoming less willing to lend to consumers increased to a level that has never not been associated with a recession,” Doll said in an email, the emphasis his.
Corporate profit margins have also contracted by 1.5%, a level seen in prior recessions, he said.
On top of all of this, the impact of the Fed’s tightening campaign likely hasn’t been fully felt yet. And after both sticky inflation data and an exceptionally resilient jobs report for January, the expected terminal rate for the Fed continues to rise, Doll said.
“What the Fed already did last year has not yet affected the economy,” he told Insider on Friday. “What the Fed does typically affects the economy six to 12 to 18 months after they do it, and they didn’t even start until March of last year.”
All this in mind, with Doll awaiting a mild recession, he expects earnings estimates to contract, sinking the the S&P 500 to around 3,400, about 16% lower than current levels. If a more normal recession (more severe than a mild downturn) comes, Doll said the index could fall to 3,000.
“The S&P’s current 18.5x multiple on 2023 expected earnings of $224 looks too rich given current economic uncertainties and our economic expectation,” he said in an email.
As for timing, Doll said he expects a recession to unfold before the end of 2023. He said that stocks historically don’t bottom before a recession happens.
Doll’s views in context
A sizable camp of Wall Street strategists and economists now sees a recession ahead. The Fed’s recession probability tracker based on the yield curve also now puts the odds of a recession at 57%.
Earlier this week, JPMorgan’s Chief Global Markets Strategist Marko Kolanovic warned that recession is guaranteed if the Fed is truly committed to returning inflation to its 2% target. In January, inflation still sat at 6.4%.
Savita Subramanian, the top US equity strategist at Bank of America, also said this week that an indicator the bank developed shows the US economy is heading toward a recession — which is the base case for the bank’s economists. The indicator has dipped negative in non-recessionary instances, but it went deep into negative territory during the early 2000s recession, the 2008 downturn, and the 2020 COVID-induced recession.
“Our US Regime Indicator dipped its toe into Downturn territory this month; if we get a 2nd month of confirmation, we will officially be out of Late Cycle and in the abyss,” she said in a client note. Subramanian expects the S&P 500 to fall as low as 3,000, a view shared by Morgan Stanley’s Mike Wilson.
The lack of a rebound for oil and copper prices despite the reopening of the Chinese economy also indicates the world economy is in a downturn, according to experts like Robin Brooks, chief economist at the Institute of International Finance.
Not everyone sees a recession ahead, however. For example, Goldman Sachs’ top US economist Jan Hatzius this week lowered the probability that recession comes from 35% to 25%, thanks to a strong labor market.
Regardless of whether one sees a recession or not, the consensus seems to be that stocks are already priced for a non-recessionary outcome, and investors aren’t paying enough attention to downside risk, as Doll argues.
Goldman’s Chief US Equity Strategist David Kostin — despite not seeing a recession ahead — has the same near-term and end-of-year target for the S&P 500 of 4,000, slightly lower than today’s levels.
Morgan Stanley Wealth Management’s CIO Lisa Shalett recently pointed out the market’s steep valuations.
“Rich valuations offer little room for error, as bullish risk-taking counters central bank guidance,” she said. “Folklore suggests not to fight the Fed for a reason.”
And here’s JPMorgan’s Kolanovic: “With equities trading near last summer’s highs and at above-average multiples, despite weakening earnings and the recent sharp move higher in interest rates, we maintain that markets are overpricing recent good news on inflation and are complacent of risks.”
Stocks are up 14% since October and 6.6% this year. How well the US economy and corporate earnings can hang on as the Fed continues to raise rates with plans to keep them elevated through the rest of the year will likely determine how stocks fare in the months ahead. If trouble hits, like Doll and much of Wall Street expects, stocks could extend their fall to new lows.