Despite the strong outlook for 2023, the stock market continues to shrug off the effects of persistent inflation and rising interest rates this year. The S&P 500 has risen more than 12% so far this year to a record high, beating the blue-chip index’s average annual gain of about 10% since 1957 in less than six months. A strong first-quarter earnings season and a resilient economy have helped support the stock market’s strength, but some top Wall Street strategists worry a recession is on the way.
Stifel chief equity strategist Barry Bannister said in a note on Tuesday that he expects the S&P 500 to fall about 10% to 4,750 by the end of the summer. The Wall Street veteran argued that inflation-adjusted stock market returns could be flat for a decade in 2023 and cited three main reasons for his bearish outlook:
The first, perhaps unsurprisingly, is “sticky” inflation. Bannister has warned in recent months that the Fed believes it has already “reaped” the deflation that typically accompanies a recession in its five-quarter “quasi-recession” that ends in the second quarter of 2023. In May, he even argued that this means Fed officials’ goal of getting inflation back to 2% is merely a “pipe dream.”
Bannister is concerned that a surge in spending on services, combined with rising health, finance and insurance costs, will lead to continued inflation in key sectors of the economy. Higher than expected house price inflation, slower productivity growth and continued wage growth will result in “moderate stagflation,” he says.
This low-growth, moderate-inflation outlook could lead to a 500-point drop in the S&P 500’s price-to-earnings multiple — the metric used to value the index — as investors price in lower potential earnings growth and higher costs, the strategists warned.
After this year’s surge in stock prices, the S&P 500 is trading at just over 23 times earnings. The Wall Street JournalThis is higher than the historical average price-to-earnings ratio of 19.4 times.
Bannister isn’t the only one sounding the alarm following the recent stock market rally. Wells Fargo strategist Scott Wrenn urged investors to “prepare for further volatility” in a note on Wednesday. “There are several potential issues that could cause financial market volatility in the coming months,” he wrote.
Like Bannister, Wren said the timing of the Fed’s rate cuts could be a trigger for a market pullback. Wren said Fed economists expected three rate cuts this year in March, but are likely to expect only one or two cuts when the Federal Open Market Committee meets in June. That could be problematic for stocks, as many investors still expect multiple rate cuts this year, which (usually) stimulates the market.
“Will the old market cliché of ‘sell in May and be done’ still hold true this year? That remains to be seen, but we [S&P 500] “We expect to see a significant upswing by the end of the year,” Wren wrote.
Wells Fargo strategists also warned that rising food and energy prices will continue to weigh on consumer confidence and that the U.S. election is likely to bring volatility to markets. He encouraged investors to look beyond the highly valued technology sector to so-called “blue chip” companies with strong balance sheets, low debt and solid profitability in sectors such as industrial, materials, energy and health care.
Similarly, Stifel’s Bannister recommended sticking to “quality” stocks in so-called “defensive value industries” that tend to be more stable, such as the health care, consumer staples and utilities sectors.
While both strategists see potential pain ahead for the market, it’s not all bad news. Wells Fargo’s Wren concluded with some wise words that all investors need to remember from time to time: “Stock price declines, if you see them, can present opportunity. Be prepared, have a plan, and fasten your seat belt.”
