By Josef Adinolfi
Across markets, familiar trading patterns in stocks, bonds and commodities that have held for months are beginning to unravel as financial markets grapple with expectations that the U.S. economy will slide into recession next year, market analysts told MarketWatch.
The S&P 500 index on Wednesday experienced its longest losing streak in nearly two months, although long-term government bond yields continued to fall while crude oil prices fell to their lowest levels this year.
For most of this year, falling Treasury yields have coincided with higher stock valuations as the cost of borrowing became a critical concern for markets.
Now that dynamic appears to be shifting, a sign that investors are bracing themselves for a looming recession, though the stock market has yet to fully embrace that view.
“Copper prices are down, oil prices are down, despite the inventory report coming in lower than expected and China reopening. The recession is weighing on everything,” said Gene Goldman, chief investment officer at Cetera Investment Management.
US-traded crude prices are down 10.5% so far this week to $71.59 a barrel, according to FactSet data. And while copper prices have edged up slightly during that time, they’re still down more than 13% so far this year. The yield on the 10-year government bond has fallen by around 25 basis points since the beginning of December.
So far this week, the S&P 500 is down 2.8% after staging a rapid rally in mid-October. Sharp but short-lived rallies are not uncommon in bear markets, said Steve Sosnick, chief investment strategist at Interactive Brokers.
So far, shares have remained surprisingly buoyant even though expectations for corporate earnings growth in 2023 have softened.
Back in June, equity analysts had forecast earnings growth of 10.3% in 2023, according to FactSet’s median estimate. By December 7, expectations had fallen to just 5.9%. And some on Wall Street, including Morgan Stanley’s Michael Wilson, expect earnings to fall in 2023.
But in the bond market, falling longer-dated bond yields combined with an increasingly inverted Treasury yield curve are sending a pretty strong signal that markets are expecting a recession next year.
“Recession expectations are strengthening and rightly so. We’re starting to see markets pricing it in, which isn’t that surprising after the rally we’ve had over the past month,” said Jake Jolly, senior investment strategist at BNY Mellon Investment Management.
There’s an old saying on Wall Street that the bond market is a more reliable guide to what the US economy has in store.
“When stocks and bonds are at odds about the economy, I tend to trust bonds more,” Sosnick said.
If true again, it would mean stocks are likely to be trending lower.
“If you look at the S&P 500 at 3,930, that effectively means earnings aren’t coming down next year. But in a recession, earnings typically fall 10-15%,” said Ron Temple, head of US equities at Lazard Asset Management.
At least so far, the US economy appears to be holding up well, although the US Federal Reserve is raising interest rates by around four percentage points this year.
The US job market added 263,000 jobs in November, while US gross domestic product grew 2.9% in the third quarter. Even the ISM barometer of activity in the service sector, released earlier this week, was above 55%, a level that indicates growth.
More problematic for the Federal Reserve is the fact that wages for the year to November rose 5.1% from 4.9% in the previous month. Investors are concerned that unless the economy cools, inflation will continue to run hot.
If both the economy and inflation hold up, many on Wall Street expect the Fed to continue raising rates and plunge the economy into recession.
According to the CME’s FedWatch tool, Fed funds futures markets on Thursday expect the Fed’s interest rate to peak between 4.75% and 5.25% in March or May before the Fed closes of the year when the rate cut begins.
This implies that markets are anticipating a sharp downturn sometime before the middle of next year, Temple said. When that happens, stocks will likely be in even more pain.
U.S. stocks recovered somewhat on Thursday, with the S&P 500 gaining 0.7% to 3,961, while the Dow Jones Industrial Average was up 133 points, or 0.4%, to 33,732. The Nasdaq Composite gained 1.2% to 11,085.
-Joseph Adinolfi
(ENDS) Dow Jones Newswires
12-10-22 0845ET
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