Investors think of the stock market as forward-looking, but valuations often price in an earnings recession only after “it is knocking on the door,” warns Lauren Goodwin, an economist and portfolio strategist at New York Life Investments.
U.S. earnings results typically serve as the last domino to fall in terms of economic data heading into a recession, Goodwin said in a Tuesday note to clients. She also said that while corporate margins have held up, revenues have been declining in most industries, particularly in the technology and consumer-discretionary sectors, which have benefited from the recent rally in stocks.
Stocks were down sharply on Tuesday, but the technology-heavy Nasdaq
was still about 10% higher on the year to date, according to FactSet data. The S&P 500
was up almost 4.5% on the year, while the Dow Jones Industrial Average
clung to a 0.3% advance so far in 2023.
“In our view, this mismatch between fundamentals and price action cannot hold,” Goodwin said.
What about the roaring labor market? She pointed to how the U.S. economy has often added jobs ahead of past downturns (see chart). Specifically, Goodwin found average payroll gains were still positive a month before the start of nine out of the past 10 U.S. economic recessions.
“The recent rally may have begun from reasonable valuations and low investor confidence, but it reflects a temporary increase in liquidity and a monetary policy pivot that, in our view, is not coming,” Goodwin said.
While the bond market started to price higher rates for longer after the blowout January jobs data, it took last week’s annual 6.4% rate on the consumer-price index for the stock market to begin adjusting to that likely reality, she said.
The 2-year Treasury
rate jumped 9 basis points to 4.71% on Tuesday, its highest level of the year, while the 10-year Treasury
rate climbed 11 basis points to 3.93%, according to FactSet.
“At the first sign of weakness in U.S. payrolls, we believe a strongly defensive portfolio posture would be appropriate,” Goodwin said.