Wall Street has been scrambling to readjust its recession calls since the Fed raised rates last month, and now most models predict the probability of a recession within the next year has doubled to more than 50%, reports an article in Barron’s. As a result of those predictions, Treasury yields have dropped as investors seek other refuges.
But stocks have risen 3% since the rate hike, with many analysts forecasting double-digit earnings growth from now until the end of the year. Those analysts “are in la-la land,” Vincent Deluard of the StoneX Group told Barron’s. His model, which factors in the price of oil and the prime rate, shows that S&P 500 earnings could contract by 4.7% over the next 12 months. Deluard makes two points: that analysts continue to be bullish in the consumer sectors despite declining sentiment, rising inflation and the cost of credit, and that he expects a significant deceleration in earnings growth, which will then turn negative next year. Squaring those two predictions would require the “soft landing” situation—a disinflationary boom, where inflation dissolves swiftly while the economy still produces double-digit earnings growth—that many now consider unlikely.
Instead, inflation will stay painfully high this summer in an inflationary boom, unable to shift into that disinflationary boom scenario, Deluard shares with Barron’s. Though commodity prices have recently declined, there hasn’t been any meaningful disinflation in the energy sector, and oil remains in short supply, leading some energy analysts to remain bullish on it. Those analysts predict energy prices to stay high for longer than expected.
Adding all those factors together, Deluard maintains that U.S. stock valuations are not appealing, with the “true forward S&P 500 price-to-earnings ration…around 20,” the article details. But his forecast assumes that the Fed will continue to fight inflation. Other strategists suggest that the central bank is starting to turn dovish, pointing to the spike and then drop in the 2-year Treasury yield as a typical sign for a Fed pivot. Both scenarios indicate that inflation will remain elevated; if it doesn’t, it means the Fed has stayed hawkish at the expense of growth. In either case, Wall Street earnings expectations still don’t match reality.