Yahoo Finance Live takes a look at year-end forecasts on the first full market day of the second half of 2023. Brian Levitt, Invesco Global Market Strategist, and Yelena Shulyatyeva, BNP Paribas Senior U.S. Economist, discuss inflation and the possibility of an economic downturn. Shulyatyeva says, "We are expecting a recession this year." While Levitt says, "The economy is still too strong to be talking about a near-term recession."
Video Transcript
DIANE KING HALL: It is our first full market day of the second half of 2023. After a better than expected first half for stocks, the S&P 500 rallying so far year to date up over 16%. The outlook towards the year's end is mixed, with Goldman Sachs the only of the big banks seeing upside for the index to close the year, their expectation hitting 4,500 in the analyst forecast. Morgan Stanley, the biggest bear among the large banks, has the S&P 500 falling all the way to 3,900 by the end of the year. With more economic data on the horizon, uncertain Fed moves, can stocks continue to rally? Or is there downside from here?
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Joining us now with a deep dive is Yelena Shulyatyeva, BNP Paribas US economist, and Brian Levitt, Invesco Global Market Strategist. Brian I want to start with you, and we'll start with an outlook for the second half of this year. NASDAQ was the clear winner so far. What's your expectation for the back half?
BRIAN LEVITT: Actually, you're starting to see a little bit of broadening out in terms of market participation. So it was a very defensive high-quality trade in the spring, with only a handful of names driving performance. And so we are enthused that we're starting to see a little bit of broadening out of that. In fact, our indicators are pointing towards a market that's sniffing out a recovery from what had been a weak patch here.
Now, that's not necessarily the beginning of the new elongated market cycle, but one that provides a nice tailwind for markets. As the market's starting to look at inflation that's coming down pretty rapidly and a Fed that's got to be near the end of its tightening cycle, that starts to create, at least in the near-term, a better risk on backdrop for equities.
Now, look, we still have to deal with what the lagged effects of all this policy tightening is at some point. But I always go back and advise investors that in the couple of years after the peak in inflation, which was last June, and a couple of years after the end of Fed tightening, stocks can do very well and have historically done very well.
BRAD SMITH: Yelena, even as Diane was mentioning, where some of the targets for the largest banks here in the US, where they sit as of right now, many of them still in comparison to where we're at right now, they seem still bearish. So what is that Fed risk that still remains at this point?
YELENA SHULYATYEVA: I think we need to look at the economy and just go back to the fundamentals and see where the economy is and what outlook is for the second half of the year. We are very, actually, bearish on that front. So we expect economic downturn to start this year in the second half. We're already in the second half. And we are seeing a lot of signs that is already happening.
We saw manufacturing slim on Monday. That was really weak on all fronts-- employment, production, new orders. So that was a weak indicator. We see some upward movement in jobless claims, so that is a concern. And we see some bankruptcies rising. And we think the decline in corporate profits will be detrimental to companies' plans on expansion. And in turn, that will result in large layoffs in the second half of the year.
DIANE KING HALL: By downturn, are you actually expecting a recession this year?
YELENA SHULYATYEVA: Yes, we are. We are expecting a recession this year. I know that the data has been-- some data has been surprising to the upside, but others are surprising to the downside, as well.
So look at personal consumption expenditures. We received the report last Friday and that showed a significant slowdown in consumer spending. So compared to the first quarter of this year, the two months of this year only show 0.8% growth in consumer spending in real terms, compared to 4.2% in the first quarter. That is a significant slowdown in one of the biggest main engines of the economy. So I think we are actually slowing down pretty fast.
BRAD SMITH: And, Brian, on your side there, you're a little bit more optimistic about where we're at right now. So does that anticipate, then a recession that is better than feared? Because if there has been a story or a through line that we've seen from some companies who have reported earnings this year, investors have reacted to the fact that it's been better than feared so far. And so what does that spell out for the type of recession that we might even see?
BRIAN LEVITT: Yeah, it has been better than investors fear. This has been the most anticipated recession that you could imagine, and it hasn't happened yet. And the economy is still too strong to be talking about a near-term recession.
Now, are you hitting some of those guideposts? Sure. You've got a deeply inverted yield curve and banks are starting to tighten lending standards, so you'd be naive to think that there's not an economic downturn coming. But the market is not the economy, and that's what is critical here.
The market was down 9% last September, getting ahead of what was expected to be a pretty significant economic downturn here. The market was down 25% peak to trough last year. Again, the market leads.
Now, if you go back historically and you look at the more mild recessions, like in 1981, like in 1991, stocks tend to decline 20% to 25% and hit a new high within one or two years. And that seems to be precisely the path that we're following right now. In fact, this is very reminiscent of the '80, '81 environment, which I understand that I talk about a lot, even though I was only five years old. But I did read about it a lot in textbooks.
And in 1980 inflation peaked in March. The Fed did raise rates through the end of the year under Paul Volcker. There was a much anticipated recession, it happened.
But if you had invested when inflation peaked in March '80, or you had invested when the Fed was done tightening in December '80, you were thrilled by '82, '83, '84. In fact you, were thrilled out to 1999. So I'm not suggesting a 17 year bull market, but this is following a very similar path to what we saw in '80, '81.
DIANE KING HALL: So, Brian, I got to ask you-- so I was also a child then, as well. Brad wasn't even a thought in his parent's mind, possibly, then. I don't know, I don't remember the exact date. But I want to ask you just a follow up question about how the market is potentially. Is the market actually pricing the odds of recession right?
BRIAN LEVITT: Well, the market did. So when you got down to 3,600 on the S&P, that was a market that-- let's just use back of the envelope. That was from a peak earnings decline, call it 20%, down to 180.
And then what multiple are you going to pay on that? The expectation was, as the economy moderates, interest rates start to come down, and we saw multiples bottom at 18. And could they get to 20 in a lower interest rate environment? So 20 times 180 gets you to the 3,600. So to me, that's the bottom.
Now, we've had this nice run as things have been more resilient and inflation has come down pretty rapidly. Now, we do have to still think about, well, when do we get to the beginning of this nice, new, elongated cycle. Right now what the market is telling us is we're getting a recovery feel here, and that recovery feel is more of a risk-on type of an environment.
Is this the beginning of the recovery, then the expansion, the new cycle? That might be overstating. You likely see some retracement in the early part of 2024 as you start to think about a recession. But my point is to say that any type of retracement here, you're not going to see the 3,600 bottom again. And that would represent a buying opportunity, because that type of retracement is going to be in what's likely to be a mild recession.
Why mild? There's just not a lot of leverage in this economy. Banks are well-capitalized, the businesses are well-positioned, this is very unlikely to be a significant recession. We're just working off this bizarre COVID cycle, and now that's why the Fed's going to be done sooner than later. And that creates over the next years a nice backdrop for investors.
BRAD SMITH: And so we'll hear some of the meeting minutes from their last meeting this week. We're also going to get more data for them to really parse through at their next meeting in the form of jobs. And so what do you expect to begin to show up in that data, if anything materially different from what we've already seen in the monthly jobs report
YELENA SHULYATYEVA: I think what the Fed really needs to see before they make the next move at the July meeting is the senior loan officer survey. So they will have the summary of the survey when they meet, when they get together at the July meeting. We will not see that until the following Monday.
But what we have seen, the signs from other data from the Texas Lending Survey and some commentary in the Beige Book, is telling us that lending conditions are tightening, and tightening pretty rapidly. So that will put us like a brake on economic growth in our view, and this is something the Fed is waiting for, to see how it impacts the economy. It's probably not just another inflation report or another payroll report, those data are, obviously very important to the Fed. But they also need to see what kind of an impact of their past tightening is having on the economy.