The Bear Case
The bear case for stocks is based mainly on macro and fundamental conditions. A recession is on the horizon in H2 2023, and recessions are bull market killers. New Deal Democrat, who maintains a set of coincident, short-leading, and long-leading indicators, has been documenting the slow deterioration of economic momentum, which first started in the long-leading indicators designed to spot economic weakness 12 months ahead. The weakness spread to short-leading indicators, which have a six-month time horizon, and they are finally appearing in the coincident indicators. His latest update shows that of his 14 long-leading indicators, one is positive, three neutral and 10 are negative. Among his short-leading indicators, the score is four positive, four neutral and six negative. The coincident indicator dashboard shows two positive, three neutral and five negative. He concluded:
The “Recession Warning” which began at the end of November for this year remains, as all three of my primary systems remain consistent with a near-term recession.
These signals, along with the deterioration in small business optimism, are pointing to a hard landing in the near future.
Possible Sentiment Support
On the other hand, most of the recessionary conditions may already be discounted. Carl Quintanilla of CNBC reported that a recent JPMorgan survey of investors shows that a recession that begins in H2 2023 is already the consensus call.
In addition, Lisa Abramowicz at Bloomberg reported that, according to the April BoA Global Fund Manager Survey, global managers’ allocation to equities relative to bonds has dropped to its lowest level since 2009.
As well, hedge funds have built up record shorts in S&P 500 futures, which should be contrarian bullish.
On the other hand, bearish futures positioning has been no guarantee of higher stock prices. In fact, an analysis of the recent record shows that investors should bet with and not against significant long or short positions in hedge fund positions in S&P 500 futures.
The recent behavior of the VIX Index and high yield bond relative performance are also pointing to a risk-on sentiment backdrop.
Historical Templates to Consider
So where does that leave us? It’s possible that both the bulls and bears are right. A recession is probably in the cards, but most of the deterioration may have already been discounted, though European equities appear to be in a better position than the U.S.
Fast forward to 2023. The Fed and other major central banks were near the end of their tightening cycles when they were hit with a banking crisis, which was sparked by the failure of Silicon Valley Bank but spread to the systemically important Credit Suisse. The crisis passed and the banking system appears to have stabilized, but valuations are still challenging. The S&P 500 trades at a forward P/E of 18.2, which is elevated by historical standards especially in light of continuing negative earnings revisions that put upward pressure on the P/E ratio.