MIKE DOLAN: No champagne popping despite receding recession fears

London — Even as fears of a 2023 US recession recede and stock market bears concede defeat, there is scant sign of party mode.

This pandemic-distorted cycle — compounded by war, energy price shocks and reshaped geopolitics — is proving too complex to extrapolate easily.

After wild swings of output, prices, employment, liquidity and interest rates, firm convictions about the precise onset of “technical” recessions — or even previously reliable gauges of bull and bear markets — have all become a bit suspect.

Endless nuance is now demanded — how to square 20-year-high interest rates with near-record low unemployment; a credit squeeze with rising interest income on savings; a demand boost from disinflation but waning corporate pricing power; or an artificial intelligence boom alongside a factory slump.

Whether on a domestic or global scale, aggregate views of the economy, or stock market, right now are probably misleading.

But as bets on an economic “soft landing” become consensus again, Wall Street’s main stock benchmark has risen back to within 5% of its record highs just above 4,800 points — a 30% rebound from 2022 lows that has almost reversed last year’s 27% peak-to-trough plunge.

A bull to bear market and back again in little more than 18 months — or so it seems.

The zeitgeist of the week for many investors was Morgan Stanley’s US stock market guru Mike Wilson, who has doggedly held one of the most bearish year-end S&P 500 forecasts of 3,900, admitting to clients “we were wrong” — citing a disinflation spur that has gone further and persisted longer than anticipated.

Stellar call

Far from chastened however, Wilson remains as bearish for next year. His 4,200 call for June 2024 is still 8% lower than from here.

The mea culpa was remarkable however, partly because of Wilson’s past success — not least a stellar call on the near V-shaped market recovery around the pandemic rescues three years ago that prompted investors to sit up and take notice.

And global funds still cling to underweight equity positions seven months into what has been a bumper year for many sectors. But it also appeared to be a capitulation of sorts from one of the last major bears on the Street. Only last week, Morgan Stanley upped its 2023 US economic growth forecasts due to a rethink on infrastructure investment.

Of course, notoriously tricky point forecasting is full of swings and roundabouts. You win some, you lose some. And Morgan Stanley is far from alone, as forecasts and outlooks have shifted around midyear.

Barclays economists told clients this week they had “jettisoned” forecasts for a US recession by the fourth quarter, pushing expectations of a “mild downturn” into 2024. And the IMF, which nudges and tweaks its own forecasts at least four times a year, on Tuesday pushed its 2023 full-year US growth forecast up to 1.8% — 0.4 points higher than it saw in January. So the coast seems to have cleared for markets now lapping up hopes of disinflation, peak rates and a soft landing.

Much will hinge on how long global portfolios remain persistently underweight equity, as that offers oxygen to market pricing and fuels demand via eventual rebalancing.

But that has its limits.

Technical definitions

A Natixis Investment Managers’ survey of its portfolio managers and strategists shows fewer than one-in-five now see a significant risk of recession this year — and yet, they still warn against “complacency” and half expect the stocks rally to “fade away” by year-end.

To some extent, an obsession with technical definitions of recession as an investment guide is part of the problem.

After all, early data slices and then revisions have had the eurozone economy edging in and out of recession at least three times this year and the region’s stocks are still up 13%.

The complexity of this peculiar cycle confounds relatively simple calculations.

Chief among the puzzles is the variable impact of sharply higher interest rates on both households and companies. Many households with excess pandemic savings — estimated by the San Francisco Federal Reserve as recently as May to still total almost half-a-trillion dollar — and with fixed-rate mortgages, many have been relatively immune to the Fed’s 5 percentage-point credit squeeze to date.

Indeed, those with savings on deposit may be seeing significant offsetting windfalls too.

And the same may be true in the corporate word.

Societe Generale strategist Andrew Lapthorne details how different segments of the market have been hit by higher interest costs — small caps much more than large caps in particular.

For a start, he showed how the ratio of earnings to interest payments for the Russell 2000 small caps was just 2.5 times — compared with 13 times for the top 10% of the S&P 1500 index.

Excluding financial firms, this 10% — accounting for more than 60% of index market cap — had seen no rise in interest payments so far in the Fed campaign and holds 70% of the cash.

And if overall US corporate cash earned Fed interest rates, it would be generating almost $100bn per annum extra in interest income compared with two years ago — a near 5% boost to overall earnings, skewed to the big caps.

“This simply means that interest rate effectiveness has been blunted,” he concluded.

Reuters