Case for Stocks Is Seen in Model Showing Economic Bottom Is Past

(Bloomberg) — US stocks have defied skeptics and rallied this year in the face of bank collapses, continuous fears of a recession and what’s expected to be the gloomiest stretch for corporate profits in years.

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One potential explanation for why this is happening is things may not be as bad as they seem. In fact, according to a Bloomberg Intelligence model known as the Economic Regime Index, the worst of America’s economic pain appears to have happened months ago.

The index analyzes monthly changes in key inputs that factor into calling a recession, including capacity utilization, jobless claims, manufacturing and sentiment. It indicates that an economic downturn possibly started in June and bottomed in December. While the model still signals weakness in the economy, as long as it stays above its late-2022 lows the outlook is favorable for the S&P 500 Index, BI says.

“This can be contentious as far as spurring debate on whether we’re in a recession, headed for one or were already in one,” said Gillian Wolff, senior associate analyst at BI. “The macro landscape seems to have reached its worst place at the end of 2022, so there will likely be significant support for stocks as a result going forward.”

Looking at the eight recessions since 1970, the S&P 500 returns 8.9% on average over the three months after BI’s model hits its low — and 20% over the 12 months after that nadir. The broad equities benchmark is up 7.8% this year.

Investors are growing increasingly confident that the Federal Reserve will at some point this year end the cycle of interest-rate hikes that spurred the S&P 500’s 19% plunge in 2022, its worst performance since 2008.

“Fighting the Fed” has been a winning strategy for months, with stocks rising as the central bank lifted its benchmark rate to the highest since 2007. The S&P is heading toward a 20% advance from its October bottom, a threshold many investors define as the start of a bull market. Not only that, but the VIX Index — known as the market’s fear gauge — is at its lowest since January 2022, and put-to-call ratios are falling, meaning there’s reduced appetite for hedging against losses.

Bull Already Running

Tim Hayes at Ned Davis Research Inc., who correctly called the timing of last year’s bear market, says a bull market in US stocks is already happening.

“The market has been responding to the signs that reduced inflation will enable the Fed to end its tightening policy,” said Hayes, the firm’s chief global investment strategist.

But not everyone sees it that way. In fact, there are plenty of bears running around. Investors have pulled cash from US equity mutual funds and exchange-traded funds in 11 of the year’s first 15 weeks, data compiled by EPFR Global show, defying the strongest first quarter for the S&P 500 in four years.

For strategists at Goldman Sachs Group Inc., the outflows “show a lack of sponsorship” for the equities strength, underscoring the mismatch this year between flows and performance that may “mean-revert.” The bank’s model that factors in a variety of flows data suggests the S&P 500 should be about 6% lower from current levels.

Until now, surprising strength on the part of the consumer has bolstered the bulls’ case. But it appears household spending is cooling in the face of high inflation and steeper borrowing costs.

For stocks, the key question may not even be if there’s a recession ahead in 2023 — it’s how long it will it last? Shorter recessions have led to more rapid rebounds, according to BI. Fed staff advisers, for their part, foresee a “mild recession” later this year.

So far, banks’ earnings results have reassured investors about the financial system’s health. That’s helped ease worries of a projected 8% year-over-year contraction in S&P 500 earnings, which would be the worst performance since 2020.

Sam Stovall, chief investment strategist at CFRA, is sticking with his optimistic call for US equities even though he expects a shallow recession may still occur. His rolling 12-month target of 4,575 for the S&P 500 is almost 11% above Friday’s close.

“The real question is whether the market has already factored in a mild recession,” Stovall said. “Many people are expecting a tsunami of disappointing guidance. But if that’s already factored into share prices, the only way to be surprised from here is to the upside.”

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Source: https://finance.yahoo.com/news/case-stocks-seen-model-showing-124353345.html