The stock market "has cracked this year", says the strategist, and there are 2 things to watch for next

The stock market “has cracked this year”, says the strategist, and there are 2 things to watch for next

As an economic downturn weighs on earnings, companies are reviving the “trust the process” slogan made popular by the Philadelphia 76ers in the post-Iverson era.

Markets, for their part, have already begun pricing in recession risks, with the S&P 500 and Nasdaq falling into bear markets this year — down 20% and 32% year-to-date, respectively — while the Dow Jones fell more than 9%.

“The market comes first, so the market has cracked this year,” Liz Young, head of investment strategy at SoFi, told Yahoo Finance Live (video above). “The market showed us its pessimism. It showed us its reaction to the microenvironment.”

Much of the market’s decline hinges on the Federal Reserve aggressively raising interest rates, and the economy slowing, given decades of high inflation: Fed Chairman Powell, recently acknowledged the risk of tipping the economy into a recession, but said thinking about pausing interest rate hikes at this stage would be “very premature”.

“Until we see consecutive months of inflation come down significantly, I expect them to keep climbing and to keep tightening,” Young said. “I think they’re pretty comfortable with tightening maybe a little too much and then trying to kind of apologize to the markets later with whatever tools they have to stimulate.”

In the meantime, Young suggested that investors watch for two other signs that the economic cycle could turn around.

Earnings contraction

A drastic contraction in earnings could be the next shoe to fall, according to Young. The market hasn’t seen a wave of downward revisions to its earnings estimates since the start of the coronavirus pandemic.

“I think the part that hasn’t been fully factored in is the contraction in earnings,” she said.

In a Nov. 4 note, Goldman Sachs cut its earnings target for the S&P 500 for the rest of the year as well as through 2024. The bank now forecast earnings for 2022 at $224, down from $226 previously. Additionally, company strategists revised their earnings forecast for 2023 to $224 ($234 previously) and $237 in 2024 (from $243).

This image was created by Yahoo Finance using the Dall-E AI image generator.  (OpenAI)

This image was created by Yahoo Finance using the Dall-E AI image generator. (OpenAI)

Young added that if the United States fell into a recession, she would expect a 10-15% contraction in profits. At the same time, she noted, the decline in profits would vary from sector to sector due to inflation.

“Goods inflation is likely to come down much faster and to a more manageable level than services inflation, which tends to be more rigid and includes things like rents, and businesses also face inflation. rigid wages,” Young said. “Thus, sectors that are goods-intensive and stand to benefit from lower goods inflation and lower commodity prices should fare better and may not suffer as large a drop in earnings. .”

Economic swing

The US unemployment rate is currently near a 50-year low, and the Fed globally sees an overheated labor market with demand for employees outstripping the supply of labor market participants.

But that could change as the Fed continues to hike rates.

“The last piece of the puzzle is that the economy is weakening, and you see real data in the economy, the labor market, inflation is coming down, things are actually contracting,” Young said.

The silver lining for investors would be that by the time the economic data stumbles, the stock market may already be in recovery mode, as stocks tend to bottom long before a recession concludes.

According to historical data from JPMorgan, on average, the S&P 500 bottoms out three months after the start of a recession and hits a cyclical bottom 10 months before the end of a recession.

“A recession is quite likely at this point — that doesn’t mean it has to be bad, doesn’t mean it has to be armageddon,” Young said. “Recessions reset the business cycle, and that could be positive in this environment.”

Bradley Smith is an anchor at Yahoo Finance. Follow him on Twitter @thebradsmith.

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