Stocks Had a Nasty 6 Months. The Second Half Could Be Ugly Too.

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It was a first half destined to haunt investors. The past six months were historically bad for stocks, bonds, cryptocurrencies, and practically every other asset class outside of commodities.

Despite its late June rally, the

S&P 500 index
dropped 20.6%, marking its worst first six months of a year since 1970. The

Dow Jones Industrial Average’s
15.3% first-half decline was its worst since 1962, while plunges of 29.5% by the

Nasdaq Composite
and 23.9% by the

Russell 2000
produced each index’s worst first half on record. The Bloomberg U.S. Agg, a broad index of fixed-income securities, fell 10.7%. That’s also its worst first half, based on data going back to 1975. In contrast, the price of oil jumped more than 40% in the U.S. during the same stretch, while many metals and agricultural commodities saw sizable gains.

As for the second half? “There are a bazillion things going on,” says Richard Bernstein, CEO of Richard Bernstein Advisors, “But there are two certainties: The Fed is going to tighten, and profits are going to decelerate.”

For now, bond markets are pricing in significant additional interest-rate hikes this year, but some earnings forecasts remain optimistic. Credit Suisse’s Jonathan Golub notes that in the lead-up to earnings recessions, the dispersion of analysts’ estimates tends to get wider—akin to the

Cboe Volatility Index,
or VIX, spiking before bear markets. That hasn’t happened, per Golub’s data. “There may be some recession concerns, but the earnings picture does not reflect that,” he says.

In fact, analysts in aggregate have been increasing their forecasts for S&P 500 revenue and earnings per share in both 2022 and 2023.

“Apparently, the analysts have yet to get recession memos from the managements of the U.S. companies they follow,” wrote Yardeni Research’s Ed Yardeni this past week. “That’s because most of them aren’t experiencing a recession so far.”

That might not be the case for much longer, if the growing consensus calling for a recession in the next 18 months is right. Some 71% of the roughly 400 global investors surveyed by Deutsche Bank in late June expect a 2023 recession in the U.S., up from just 29% in February. Another 17% expect a recession to begin in 2022, up from just a couple of percent a few months ago.

Tom Porcelli, chief U.S. economist at RBC Capital Markets, says this “may be the most anticipated recession ever.” Google searches for “recession” and related terms are as high now as they were in March 2020. Noted economist Cardi B recently tweeted to her 23 million-plus followers about a recession.

Porcelli sees a softer labor market by the end of this year, lower confidence, and drawn-down savings weighing on consumer spending—which makes up nearly 70% of U.S. gross domestic product. Add to that a likely decline in the housing market, lower capital expenditures by cautious businesses, stubbornly high inflation, and aggressive Federal Reserve interest-rate increases, and a recession is in the cards for the second half of this year or early in 2023, he argues.

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That needn’t be a deep and drawn-out contraction, like the one following the 2007-09 financial crisis, but it will contrast markedly with 2021’s rapid rebound from the pandemic recession. Porcelli sees a “mid-cycle slowdown” akin to that of 1994-95, amid another Fed hiking cycle.

The latest economic data didn’t inspire confidence in the outlook. The Conference Board’s consumer confidence gauge continued to weaken in June, falling to 98.7 from 103.2 in May. Respondents remained upbeat on the current job market, but other areas of the survey were less rosy: Expected business conditions were the weakest since 2009, and average expected inflation over the next year rose by 0.5 of a percentage point from May, to 8.0%—the highest reading in the survey’s 35-year history.

On Wednesday, first-quarter GDP was revised down to a 1.6% annualized decline. Thursday brought weaker-than-expected May consumer spending data—a 0.4% drop in real terms—and a downward revision to April’s figures. The core personal-consumption expenditures price index increased 0.3% in May, for a 4.7% annual growth rate. That was short of the consensus forecast of a 0.5% rise, but significantly above the 0.17% monthly rate consistent with the Fed’s 2% annual inflation target.

Then, on Friday, the June ISM manufacturing purchasing managers index came in at 53.0, missing the consensus forecast. It was the lowest reading since 2020. The Atlanta Fed’s GDPNow economic model is predicting a 1.0% annualized rate of decline in real GDP for the second quarter, down from a previous prediction of 0.3% growth.

This coming Friday brings June employment data, then inflation numbers are out the following week, and a potentially volatile second-quarter earnings season is just around the corner. The next Fed meeting is at the end of July.

Taken together, the data likely won’t sway the policy makers from their current rate-hike trajectory, despite decelerating economic fundamentals. It’s a tough combination for investors, and leaves practically nowhere to hide in markets.

Being meaningfully bullish today requires some mental gymnastics by investors. An economic contraction could spur the Fed to slow its pace of its interest-rate increases, putting less downward pressure on stock multiples and less upward pressure on bond yields, which move inversely to prices.

But the Fed and other central banks around the world are fixated on bringing down inflation, and it very well may take the demand-destroying weight of a recession to achieve that goal. The combination of a weaker—but not crisis-level weaker—economy and an inflation-fixated Fed portends a difficult second half for investors.

Write to Nicholas Jasinski at [email protected]