Stocks barely budged last week, with the S&P 500 shedding 0.1%. The index is now up 7.6% year to date, up 15.5% from its October 12 closing low of 3,577.03, and down 13.8% from its January 3, 2022 closing high of 4,796.56.
One of the biggest concerns in the stock market right now is the expectation that earnings growth will have been negative in Q1 for the second quarter in a row.
This outlook for weak earnings is why numerous stock market forecasters have been warning of another market pullback in the first half of this year. (A pull back that has yet to materialize.)
It’s a legitimate concern given that earnings are the most important long-term driver of stock prices.
But in the short-term, the relationship between earnings growth and stock prices is less clear. It certainly isn’t intuitive.
“S&P 500 performance has historically held up quite well after second straight quarter of y/y profit declines,” Brian Belski, chief investment strategist at BMO Capital Markets, wrote on Thursday.
From Belski’s note:
…during the 16 profit recessions since 1948, the S&P 500 rose 5.9%, on average, in the six months after the second consecutive y/y earnings decline with gains occurring 75% of the time. The average price return improved to 7.4% when stripping out periods when an economic recession also occurred. Gains were also common throughout the duration of these earnings recessions with the S&P 500 only posting losses four times, and the average annualized price return being 21.7%.
It’s the latest reminder that the stock market usually goes up.
“Based on our analysis, four of the last seven profit recessions did not coincide or immediately precede economic recessions,“ he noted.
This is hopeful as economic recessions are generally bad for earnings and stocks in the short-run.
While we’re on the subject, it’s also worth noting an economic recession doesn’t guarantee more pain for stocks.
Lori Calvasina, head of U.S. equity strategy at RBC, wrote about an instance when “stocks ignored a recession.” From her research note Monday:
…there actually is one period in history when the stock market appeared to ignore a recession – 1945. This was the recession that occurred as the US exited World War 2. It was brief, lasting from February 1945 to October of 1945, and was driven by the pivot from a wartime economy to a peacetime economy in which government spending dried up quickly. Unemployment remained low despite the fact that soldiers returning home were competing with civilians for jobs. Stock market conditions were volatile before the recession of 1945. The S&P 500 dropped 43% in the early years of the war (a bit worse than the typical recession drawdown), bottomed and pivoted sharply in 1942 between Pearl Harbor and the Battle of Midway (momentum shifted back towards the Allies once the US was fully pulled into the conflict), and rallied strongly through the end of the war (pausing only for a fairly brief 13% pullback in 1943)…
“While there are clear differences between 1945 and today, one thing that both have in common is that unprecedented historical events caused dramatic shifts in the economy that required a tough transition back to more normal conditions,” Calvasina wrote. “Time will tell whether the stock market can look past any recession that occurs in 2023-2024 as the U.S. economy completes its transition into the post-COVID era. It’s worth keeping in mind that while this would be rare, it wouldn’t be entirely unprecedented.”
The point of this discussion is not to suggest stocks are likely to go up in the near-term.
Rather, the point is that just because we get an earnings recession or an economic recession doesn’t guarantee that you’ll get an opportunity to buy stocks at cheaper levels than where they are right now.
While we may still experience an earnings recession, it may prove to be better than feared. This helps to explain why the stock market isn’t doing worse.
Reviewing the macro crosscurrents 🔀
There were a few notable data points from last week to consider:
👍 Encouraging signs for the economy. From S&P Global’s April Flash U.S. PMI report: “The latest survey adds to signs that business activity has regained growth momentum after contracting over the seven months to January. The latest reading is indicative of GDP growing at an annualized rate of just over 2%. Growth is also reassuringly broad-based, led by services thanks to a post-pandemic shift in spending away from goods, though goods producers are also reporting signs of demand picking up again.“
The New York Fed’s April Empire State Manufacturing Survey (via Notes) confirmed this development. From the report: “Manufacturing activity grew in New York State for the first time in several months, according to the April Survey. The general business conditions index climbed thirty-five points to 10.8, pointing to a modest increase in activity… The new orders index rose a whopping forty-seven points to 25.1, and the shipments index climbed thirty-seven points to 23.9, indicating both orders and shipments increased substantially after declining in recent months…”
Meanwhile, there were signs inflation cooled. From the NY Fed: “The prices paid index fell nine points to 33.0, indicating that input price increases moderated. The prices received index held steady at 23.7, suggesting the pace of selling price increases was little changed.“
Though the Philly Fed’s April Manufacturing Business Outlook Survey was less than stellar.
On the bright side, the Philly Fed’s report also signaled inflation was cooling.
💵 Household finances are strong. From Apollo Global’s Torsten Slok (via Notes): “U.S. households are in excellent shape, the ratio of liabilities to net wealth has declined 50% since the 2008 financial crisis, and household leverage is currently at levels last seen in the early 1980s, see chart below. If the unemployment rate rises, consumer spending will slow down, but the starting point for US households is very strong.“
😬 The pros are worried about stuff. According to BofA’s April Global Fund Manager Survey (via Notes), fund managers identified “bank credit crunch & global recession” as the “biggest tail risk.”
The truth is we’re always worried about something. That’s just the nature of investing.
🏦 Banking worries are fading. According to JPMorgan’s latest weekly client survey, 72% of respondents believe the worst of the regional banking crisis is over.
🇺🇸 Recession worries are fading. According to RBC Capital Markets’ analysis of S&P 500 company transcripts, mentions of “recession” are in recession.
💼 Unemployment claims rise. Initial claims for unemployment benefits climbed to 245,000 during the week ending April 15, up from 240,000 the week prior. While the number remains near levels seen during periods of economic expansion, it has been creeping higher.
💵 People want more money to change jobs. From the New York Fed’s March SCE Labor Market Survey (via Notes): “The average reservation wage—the lowest wage respondents would be willing to accept for a new job—rose to a new series high of $75,811. The increase was driven by respondents above age 45 and those with at least a college degree.“
🏚 Home sales fall. Sales of previously owned homes fell 2.4% in March to an annualized rate of 4.44 million units. From NAR Chief Economist Lawrence Yun: “Home sales are trying to recover and are highly sensitive to changes in mortgage rates. Yet, at the same time, multiple offers on starter homes are quite common, implying more supply is needed to fully satisfy demand. It's a unique housing market.“
💸 Home prices tick up. From the NAR: “The median existing-home price for all housing types in March was $375,700, a decline of 0.9% from March 2022 ($379,300). Price climbed slightly in three regions but dropped in the West.“
🔨 New home construction declines. Housing starts fell 0.8% in March to an annualized rate of 1.42 million units, according to Census Bureau data released Tuesday. Building permits fell by 9.8% to an annualized rate of 1.41 million units.
🏠 Home builder sentiment improves. From NAHB Chairman Alicia Huey: “For the fourth straight month, builder confidence has increased due to a lack of resale inventory despite elevated interest rates… Builders note that additional declines in mortgage rates, to below 6%, will price-in further demand for housing. Nonetheless, the industry continues to be plagued by building material issues, including lack of access to electrical transformer equipment.“
Here’s Renaissance Macro Research on the data: “The drag from housing is fading. The NAHB Housing Market Index improved to 45 in April, the fourth consecutive monthly gain. Changes in the NAHB HMI tend to mirror the broad ups and downs of real residential investment. Don't be surprised if housing lifts GDP in H1 '23.“
🍾 The entrepreneurial spirit is alive. From the Census Bureau (via Notes): “Business Applications for March 2023, adjusted for seasonal variation, were 451,752, an increase of 4.5% compared to February 2023. “ Applications continue to trend significantly above pre-pandemic levels.
“Projected Business Formations (within 4 quarters) for March 2023, adjusted for seasonal variation, were 33,663, an increase of 5.4% compared to February 2023. The projected business formations are forward looking, providing an estimate of the number of new business startups that will appear from the cohort of business applications in a given month.””
For more on bullish things, read: 9 reasons to be optimistic about the economy and markets 💪.
📈 Near-term GDP growth estimates remain rosy. The Atlanta Fed’s GDPNow model sees real GDP growth climbing at a 2.5% rate in Q1. While the model’s estimate is off its high, it’s nevertheless up considerably from its initial estimate of 0.7% growth as of January 27.
Putting it all together 🤔
Despite recent banking tumult, we continue to get evidence that we could see a bullish “Goldilocks” soft landing scenario where inflation cools to manageable levels without the economy having to sink into recession.
The Federal Reserve recently adopted a less hawkish tone, acknowledging on February 1 that “for the first time that the disinflationary process has started.“ And on March 22, the Fed signaled that the end of interest rate hikes is near.
In any case, inflation still has to come down more before the Fed is comfortable with price levels. So we should expect the central bank to keep monetary policy tight, which means we should be prepared for tighter financial conditions (e.g. higher interest rates, tighter lending standards, and lower stock valuations).
At the same time, it’s important to remember that while recession risks are elevated, consumers are coming from a very strong financial position. Unemployed people are getting jobs. Those with jobs are getting raises. And many still have excess savings to tap into. Indeed, strong spending data confirms this financial resilience. So it’s too early to sound the alarm from a consumption perspective.
At this point, any downturn is unlikely to turn into economic calamity given that the financial health of consumers and businesses remains very strong.
And as always, long-term investors should remember that recessions and bear markets are just part of the deal when you enter the stock market with the aim of generating long-term returns. While markets have had a pretty rough couple of years, the long-run outlook for stocks remains positive.
For more on how the macro story is evolving, check out the the previous TKer macro crosscurrents »