A stock-market paradox, where bad news about the economy is seen as good news for equities, may be running its course. If so, investors should expect bad news bad news for stocks heading into the new year — and there may be a lot of it.
But first, why is good news bad news? Investors spent 2022 largely focused on the Federal Reserve and its rapid series of major rate hikes aimed at bringing inflation to heel. Economic news pointing to slower growth and less fuel for inflation may serve to boost stocks on the idea that the Fed may begin to slow the pace or even begin to entertain future rate cuts.
Conversely, good economic news can be bad news for stocks.
So what has changed? Last week saw a slower-than-expected November consumer-price index reading. While still running very hot, with prices rising more than 7% annually, investors are increasingly confident that inflation is likely to top a nearly four-decade high of 9% in June.
See: Why November’s CPI data is seen as a ‘game-changer’ for financial markets
But the Federal Reserve and other major central banks have indicated they want to keep raising rates, albeit at a slower pace, through 2023 and likely to keep them higher than investors expected. . That has fueled fears that a recession is becoming more likely.
Meanwhile, markets are acting as if the worst of the inflation scare is in the rearview mirror, with fears of a recession now looming on the horizon, said Jim Baird, chief investment officer at Plante Moran Financial Advisors.
That sentiment was bolstered by manufacturing data on Wednesday and a weaker-than-expected retail sales reading on Thursday, Baird said, in a telephone interview.
Markets are “probably returning to a period where bad news is bad news not because rates will drive concerns for investors, but because earnings growth will slow,” Baird said. .
A ‘reverse Tepper trade’
Keith Lerner, co-chief investment officer at Truist, argued that a mirror image of the backdrop that spawned the so-called “Tepper trade,” inspired by hedge-fund titan David Tepper in September 2010, could be forming.
Unfortunately, while Tepper’s prescient calls for a “win/win scenario.” the “reverse Tepper trade” is shaping up as a lose/lose proposition, Lerner said, in a note on Friday.
Tepper’s argument is that the economy will get better, which will be positive for stocks and asset prices. Or, the economy will weaken, with the Fed moving to support the market, which could also be positive for asset prices.
The current setup is one where the economy weakens, curbing inflation but also hurting corporate profits and challenging asset prices, Lerner said. Or, rather, the economy remains stable, with inflation, with the Fed and other central banks continuing to tighten policy, and challenging asset prices.
“In any case, there is a potential difficulty for investors. To be fair, there is a third way, where inflation goes down, and the economy avoids recession, the so-called soft landing. It is possible,” wrote said Lerner, but noted that the path to a soft landing seems increasingly narrow.
The signs of a recession were on display on Thursday, when retail sales in November showed a 0.6% fall, beating forecasts for a 0.3% drop and the biggest drop in nearly a year. years. Also, the Philadelphia Fed’s manufacturing index rose, but remained in negative territory, disappointing expectations, while the Empire State index of the New York Fed fell.
Stocks, which posted moderate losses a day after the Fed first raised interest rates by half a percentage point, fell sharply. Equities extended their decline on Friday, with the S&P 500 SPX,
logging a 2.1% weekly loss, while the Dow Jones Industrial Average DJIA,
shed 1.7% and the Nasdaq Composite COMP,
Read: Another bear market: S&P 500 slump signals stocks haven’t reached ‘quick escape’ yet
“As we move into 2023, economic data will be more influential on stocks because the data will tell us the answer to an important question: How bad is the economic slowdown? That’s the key question to start with new year, because with the Fed on relative ‘auto pilot’ policy (more increases starting in 2023) the key now is growth, and the potential damage from slowing growth,” said Tom Essaye, founder of Sevens Report Research, in a note on Friday.
No one can say with absolute certainty that a recession will occur in 2023, but there seems to be no doubt that corporate profits will come under pressure, and that will be a key driver for those market, said Plante Moran’s Baird. And that means revenue has the potential to be a significant source of volatility in the coming year.
“If in 2022 the story is inflation and rates, for 2023 it will be income and the risk of recession,” he said.
It’s no longer an environment that favors high-growth, high-risk equities, while cyclical factors could be a good set-up for value-oriented stocks and small caps, he said. he.
Truist’s Lerner said that until the weight of evidence shifts, “we maintain our overweight in fixed income, where we are focused on high-quality bonds, and a relative underweight of equities.”
Within equities, Truist favors the US, a value tilt, and sees “better opportunities beneath the surface of the market,” such as the equally weighted S&P 500, a proxy for the average that stock.
Economic calendar highlights for the coming week include an updated view of third-quarter gross domestic product on Thursday, along with the November index of leading economic indicators. On Friday, November personal consumption and spending data, including the Fed’s preferred inflation gauge are set for release.