Fundamental Outlook for Stocks: Bearish
- The Dow, S&P 500 and Nasdaq 100 suffered their worst two weeks since 2020
- Traders become more concerned about a recession as the Fed battles CPI
- Next week’s data will reveal more information about growth, not inflation
Over the past two weeks, futures tracking the Dow Jones, S&P 500 and Nasdaq 100 indices are down 8.71%, 10.5% and 9.63%, respectively. You’ll have to go back to the beginning of the pandemic in early 2020 to see the same performance. Volatility has been on the rise, with the VIX market “fear gauge” up nearly 25 percent over the same time frame.
Last week we saw a rapid repricing of Fed rate hike expectations. This is because earlier this month, an unexpectedly strong US CPI report was released. Hence last week’s 75 basis point increase, as shortly before markets were only expecting 50 basis point. A more serious Fed means there are growing concerns about the health and vitality of the world’s largest economy.
The chart below shows the US CPI and real GDP forecast for 2023 (YoY). Since about March, we’ve seen economists boost their inflation estimates for the next year. That’s as bets on real GDP, which takes into account price changes, have dwindled. Earlier this year, the US economy was expected to grow by 2.5% in 2023 in real terms. Now, that number has fallen to less than 2%.
US Economic Estimates for 2023
All eyes are on PCE and NFP
as expected, Wall Street rebounded On Federal Reserve Day. This is because the central bank appears to have restored confidence in its ability to tame hyperinflation. However, that rally collapsed when disappointing housing data slipped the next day. Going forward, markets will be watching closely for economic footprints to gauge the problems of recession. Data from Bloomberg suggests a 31.5% chance of a recession next year, compared to 20 previously.
For a closer look at how inflation versus growth prints affects the economy and the stock market, take a look at the following chart below. The purple line is the CPI spread against the real GDP bets mentioned earlier in this article. Since the beginning of this year, the line has risen, indicating that inflation is increasingly eroding growth expectations.
Unsurprisingly, bets for a one-year Fed rate hike have been rising in tandem (black line). This is the expected battle that markets see the Fed fighting as inflation continues to wreak havoc on the economy. Meanwhile, the S&P 500 fell amid a combination of growing uncertainty about growth versus inflation and what higher interest rates mean for the attractiveness of stocks versus bonds.
With that in mind, all eyes will continue to be on US economic data. Next week cools down significantly in this respect. Data such as home sales, mortgage applications and manufacturing PMI will cross the wires. This will give a better idea of how growth is progressing compared to inflation, so the focus may be on recession fears. This uncertainty is likely to continue to affect risk appetite in the near term.
Why did Wall Street fall?
– By Daniel Dobrovsky, strategic for DailyFX.com
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