The stock market got off to a shaky start on the first trading day of June, with some market watchers predicting the summer blues will continue for some time to come.
The U.S. economy and stock market have performed surprisingly well in recent years, and a recession that was previously thought to be absent or delayed is now expected to be nonexistent.
While there are plenty of reasons to believe in the bulls, it would be unwise to ignore potential warning signs, which several strategists warn are starting to pile up.
“My biggest concern for this market is that there is an unexpected economic slowdown, as that is one of the few events that would legitimately trigger a major correction in stock prices,” wrote Tom Essaie, founder of The Sevens Report, noting that corporate earnings had fueled concerns last week.
On the surface, profits are strong, but he argues that’s because companies are controlling costs and adapting to a market reality: many consumers are becoming tougher and more demand-driven.The “cutbacks” are spreading across industries, from technology to retail, from Workday to American Airlines Group to Lululemon Athletica.
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That said, in an environment where markets are eagerly awaiting a rate cut from the Federal Reserve, there will always be a camp that sees bad news as good news, in the sense that any signs of weakness give the central bank the excuse it needs to cut rates.
But Essay warns that it doesn’t always work. “Two times in my career I have seen investors welcome an economic slowdown, and both times the Fed failed to cut rates in a timely manner to prevent the slowdown from turning into an economic contraction,” he writes. “That’s not to say it can’t be done this time, but catching a falling knife doesn’t work in the real world, it doesn’t work in stock trading, and I’ve never seen it work with monetary policy.”
He’s not alone in worrying that optimists are ignoring real risks.
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Andrew Brenner, head of international fixed income at National Alliance Securities, warned that there is growing evidence that the Fed may be “too focused on inflation and overlooking the weakening economy.”
And to him, the latter is no surprise: “The U.S. economy is weakening. Not in recession, but we shouldn’t go too far. But it is weakening,” as indicated by declines in consumer confidence and inflation-adjusted spending.
It responds to other voices Barons It warned that the summer at least could be volatile for markets, especially given the headwinds from high interest rates and government bond yields, which were highlighted last week.
That’s a stark difference from much of this year and last. April was a tough month, and May ended with all three major indexes performing poorly.
S&P 500
It’s still up about 5% last month and is up more than 10% this year.
In fact, Citigroup strategist Scott Kronert wrote that if the S&P 500 were valued solely on broader macroeconomic trends, it would be perfectly valued at around 4,000, a far cry from its current level of just below 5,300.
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But fortunately for the market, it’s not the only relevant metric: “We continue to argue that the S&P 500 (i.e. Wall Street) is not moving in the same direction as the overall U.S. and global economy (i.e. Main Street),” Kronert points out.
Instead, he said, the correlation between S&P 500 earnings and gross domestic product is declining, while a range of factors, from tech-related productivity gains to the rapid adoption of artificial intelligence across all sectors, will drive further earnings growth, according to previous research. Taken together, he believes the market “has historically become less fundamentally sensitive to the economy’s fundamentals. Ultimately, improved profitability across the business cycle should also support higher valuations.”
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As such, Cronath believes that despite the mixed macroeconomic environment, the S&P 500 could trade between 5,500 and 6,200, given the structural tailwinds that will boost earnings ahead of GDP growth.
Similarly, Essay notes that despite concerns, it’s not impossible the S&P 500 could rise above 5,700 if yields fall and investors start to focus more on S&P 500 earnings per share in 2025 (which are expected to rise to $270 from an expected $243 this year).
The stock market rally so far has ignored many concerns, so it’s not impossible for it to continue rallying despite the worsening situation Essay worries about, but weak economic data won’t help stocks rally if they enter a summer slump.
Email Teresa Rivas at teresa.rivas@barrons.com.
