The stock market is driven by two closely related questions. Is the economy sliding into a severe recession or not? Is today’s rally from early July just a “bear market rally,” that is, a limited uptrend, or is it a sign that the stock market has already bottomed out?
The big trends on these issues will be decided in the US, notes Handeslblatt. Whether Europe follows this trend will likely depend mainly on the course of the war in Ukraine and its impact on energy prices.
Goldman Sachs has at least one explanation for the fact that, despite recession worries, earnings estimates for European companies remain fairly stable.
1. There are recession worries, but some of the hard economic data is stronger than expected so far.
2. Many European companies make a large part of their sales outside Europe and also in business areas not directly related to consumption. Therefore, a weaker economy does not necessarily mean weaker earnings to the same extent.
3. The weak euro helps businesses sell their products on the global market.
4. Overall, inflation isn’t that bad for many companies, for sales anyway, but also for profits. Goldman already sees some pressure on corporate earnings in Europe going forward – but only very modestly compared to previous recessions for the reasons cited.
Independent US analyst Ed Yardeni is also bullish on Wall Street. He believes the US S&P 500 had already bottomed out in mid-June. Therefore, it is hoped that it will continue to grow. On the other hand, major US bank JP Morgan, which has remained bullish on stocks for a long time, has recently become a bit more cautious because the stock market has already recovered so well. He advises investors to be wary of stocks, but recommends buying commodities.
The data show a slowdown in inflation dynamics
Friday’s performance confirms Yardeni’s optimism. The S&P 500 gained 1.7%, extending its uptrend. The Nasdaq tech index rose as much as 2%. Earlier, European stock markets had also closed the week in a friendly but much more subdued mood. Germany’s stock index (Dax) rose 0.7%, gaining 1.6% for the week.
Yardeni does not expect a recession either this year or next. In this context, he tracks the evolution of the average price-earnings ratio (P/E) for the S&P 500: from 20 at the beginning of the year to 15 in mid-June to 18 today.
Here, estimated earnings for the future are crucial. As recession worries dissipate, earnings forecasts should rise again, pushing down the P/E ratio and thus giving room for stock prices to rise again, Yardeni believes.
While most economists believe a recession is highly likely for Europe due to high energy prices and possible shortages in the natural gas market next winter, the picture for the US is mixed. Bruce Kasman, chief economist at JP Morgan, sees inflation easing globally, citing falling energy prices, subdued demand and improving supply bottlenecks. In Europe, inflationary pressures could persist for longer and an economic “contraction” could already be evident towards the end of the year, he believes.
Both factors – inflation and recession – help determine the trend of stocks today. The Bank of the West cites some more specific figures for the US that show a slowdown in inflation dynamics. For example, freight rates for shipments from China have returned to last year’s levels. In addition, the index used by the Fed to measure New York supply shortfalls fell for a third straight month.
The US Federal Reserve (Fed) had initially reacted too slowly to high inflation. This raised concerns that it would have to react even more strongly later and thereby choke the economy. Then Fed Chairman Jerome Powell wanted to fight inflation more decisively. This further increased recession concerns. At the same time, yields rose in anticipation of interest rate hikes by central banks, which put pressure on the bond market and, in the case of stocks, particularly highly valued technology stocks.
US inflation eased slightly to 8.5% in July from 9.1% in June. As a result, markets are now assuming that the Federal Reserve will not need to impose after all. Because bond yields have fallen and stock prices have risen, funding conditions in the US have even eased recently – to the delight of investors.
Is the Commodity “Super Cycle” Continuing?
But isn’t it too early for the market to be happy? Because easier funding conditions make it harder for the Fed to curb inflation further. Powell will not want to be accused again of losing control of prices. There’s another problem: the US labor market is still overheated – much more so than in Europe. This argues against recession for now, but could mean the Fed will tighten more than expected. The Fed underestimated the dynamics of the labor market last year and therefore reacted too slowly.
According to Goldman Sachs, slowing inflation makes an “extreme” Fed reaction less likely. But even the US bank has yet to give the green light for a new entry into the stock markets. The trend of the global stock market largely depends on the question of whether or not there will be another shift by the Fed towards a tighter monetary policy.
But other markets are also interesting. Commodities, for example, have recently fallen significantly. This can also be interpreted as a harbinger of recession.
However, Goldman Sachs experts still believe in the supercycle for commodities. Therefore, they consider the decline to be temporary. Independent analyst Gary Shilling, on the other hand, thinks the super cycle idea is wrong.
The impact of commodity prices is complex. Weak prices are seen as a harbinger of a weak economy, but strong prices drive inflation and could thus lead to a recession again through tighter monetary policy.
George Soros is buying US tech stocks again
All in all, we can say: As inflation slows down, recession fears return. Thus, impulses from the US could remain friendly. According to the agency’s reports, the legendary investor George Soros has already increased his participation in these shares. However, with developments in Europe lagging behind and concerns about the coming winter looming large here, even a positive trend in the US is unlikely to be replicated to the same extent by Dax and the other European indices.
Further information on whether a recession is coming will be provided by economic data and corporate earnings. In the coming week, markets will once again take a close look at economic indicators: on Tuesday the ZEW index, on Wednesday data on UK inflation and second-quarter eurozone growth. Henkel and Curevac, among others, will release new data on Monday, Walmart and Home Depot on Tuesday, Tencent, Swiss Life, Cisco and Target on Wednesday. On Thursday, Adyen and Applied Materials are on the list.