The U.S. economy finds itself in a delicate position, with the possibility of avoiding a hard landing but still encountering potential setbacks for investors. According to Bhanu Baweja, UBS chief strategist, current stock prices do not reflect an approaching recession. In fact, they indicate a growth rate above the long-term trend, at 3.7%. However, if the economy does experience a slowdown, albeit not a full-blown recession, stock prices would need to adjust to account for below-trend growth. This adjustment could lead to downward revisions in earnings and lower market performance, without reaching a hard landing scenario.
Baweja highlights the probability of a soft landing for the economy, which does not necessarily guarantee the same outcome for earnings. The consensus estimates for the S&P 500 index suggest a significant 12% increase in earnings growth. Achieving such strong growth would require nominal gross domestic product (GDP) to grow between 5% and 6%, accompanied by margin expansion. However, these targets may be challenging to achieve as UBS projects a more modest nominal GDP growth of 2.4% in 2024. Additionally, historical correlations indicate that margins might actually decline from 11% to 7%. Consequently, even with ongoing economic expansion, negative earnings growth might be on the horizon.
While various indicators point towards a soft landing, it is important to note that the S&P 500 is already trading at a level that aligns with historical patterns. Despite recent declines, the index is still up by double-digit percentages year to date.
In summary, while the U.S. economy has the potential to avoid a hard landing, investors must navigate through challenges ahead. Stock prices need to adjust to below-trend growth if the economy experiences a slowdown. Additionally, achieving high earnings growth rates may prove challenging in light of modest nominal GDP growth projections and potential margin contractions. Finally, it is crucial to recognize that the S&P 500 is currently trading at a historically realistic level.
The Outlook for the Economy and Stock Market
As investors remain optimistic about the economy, it is important to consider the role of monetary and fiscal policy in turning recoveries into expansion. The Federal Reserve’s strategy for a soft landing relies on higher real interest rates, which does not support the case for sustained growth. As a result, leading indicators are expected to pause, potentially putting downward pressure on the market as growth expectations stall.
While a hard landing would cause earnings to decline, it is not the only scenario to consider. Lower earnings could be a result of weaker, non-recessionary growth. This indicates that there can be a decrease in earnings without a full-blown economic downturn.
Stifel Market Strategist Barry Bannister shares a similar perspective and forecasts a relatively subdued end to 2023 for stocks. He predicts that the S&P 500 will finish around 4,400, representing a gain of nearly 15%. However, this falls short of the intraday high of 4,607.07 set in July.
Bannister expects the economy to heat up in the next three to six months, but he does not believe this will translate into new all-time highs for equities. Instead, he anticipates that inflation will stabilize above the Fed’s target of 2%, leading to the continuation of tight financial conditions that can limit equity valuation.
Although reaching the 4,400 level would not fully recover recent market losses, it would provide some relief. As they say, better late than never.
