We are at a turning point in stock markets, but with what timing?

In the previous post I presented some statistics regarding the profitability of the stock market following sharp downturns such as the one we are currently experiencing, let us now look at the macroeconomic picture and the timing for the recovery of stock prices.

The season of the release of quarterly earnings of publicly traded companies is now drawing to a close after providing a salutary shock to the markets.

In fact, as we know, a long series of major companies have had to show declining earnings and, more importantly, have revised their forecasts for future earnings downward.

In essence, some important sectors of the U.S. economy are telling us that:

The economy is slowing rapidly.

The most exposed companies (retail sales, real estate, internet services) are bracing for this slowdown to persist through the rest of the year.

The same thing is apparent from the latest data from the U.S. Bureau of Economic Analysis (BEA), according to which U.S. corporate profitability peaked in the second quarter of last year and has been steadily declining ever since (the current quarter marks the lowest level since the fourth quarter of 2020).

The fall in Americans' personal income is even worse. According to the Federal Reserve Bank of St. Louis economic database, one has to go back to the second quarter of 2009 to find a comparable decline (that quarter was right in the middle of the infamous subprime financial crisis).

To sum up: Americans have less extra money to spend, while companies, faced with falling profits, will not raise wages further; instead, they will try to cut costs by reducing jobs.

All these data thus point, without possibility of denial, to a slowdown in the economy that may already be headed for a recession.

What a contrast to the picture of the U.S. economy painted in the notes from the last FOMC meeting, released just the day before yesterday and related to the Fed meeting held between last May 3 and 4!

Those notes painted a still-growing U.S. economy, not knowing that three weeks later the freshest data would tell an entirely opposite story.

From the perspective of publicly traded stocks, it is obvious that, in the context of such a fast deterioration of the economy, the next reporting season due in September will see a further downward revision of earnings, especially in the sectors we mentioned (retail and internet services).

In the meantime, though, this deterioration is finally creating the drastic reduction in demand that the Fed expected to significantly reduce inflationary pressures and accelerate the timetable for:

The descent of inflation to manageable levels.

The slowdown of the interest rate hike program.

In very general terms, then, the assumption that can be made based on these dramatic findings about the U.S. economy is that stocks will remain in trouble through the summer, as long as the Fed (anchored by its last meeting held on the back of outdated data) remains aggressive.

But as early as late summer or early fall, if there are several consecutive findings of decelerating inflation data, the Fed could show the first signs of rethinking rates.

To tell the truth, reading between the lines, already there have been tentative signs to this effect from St. Louis Fed President Bullard (usually a well-known "hawk")
and Atlanta Fed President Bostic.

It is obvious that Fed members cannot openly say that their last decisions were made on the basis of data that turned out to be obsolete just three weeks later.

You can see, though, that they have eaten their lunch at the central bank and are already preparing for the necessary change of direction that the new data dictate.

That said, the question we have to ask ourselves is.

In the chase of such different economic frameworks in such a short time, will markets react in a timely manner, or will we have a proliferation of different trends as various market sectors reorient themselves to the new economic standards?

Obviously, the most likely scenario is the latter....

Inflation is expected to slow, BUT not all categories of goods will have falling prices (on the contrary, some will continue to cost more).

The drop in output is something that affects all sectors, BUT only in some sectors is this driven by a drop in demand. In others (such as semiconductors), demand is, on the contrary, getting higher.

These are just some of the BUTs that characterize the current situation, where different timelines are intertwined due to huge differences between sectors.

It is not far-fetched to say that some sectors are experiencing different economic histories as if they were living in different eras....

In practice, this means that their stock market performance will be completely different.

Of course, we can simplistically say that throughout the summer the bear market will still be the prevailing trend, while the fall, if it brings a change of course in the Fed, could initiate a new uptrend.

But the reality will be much more nuanced than that....

Just look at what will happen in the short term, that is, just in the next three months.

The summer will certainly be dominated by the narrative of slowing economic growth, uncovered by the media in just these weeks.

So the stocks with the greatest exposure to economic growth (again, Internet services companies and retailers) will see the greatest downward revisions in the stock market, while conversely, stocks with the least exposure to economic growth (i.e., companies that produce nonconsumer goods and materials used in various industries) will see much smaller downward revisions.

There will also be sectors that will have no downward revisions at all and even may have stock market gains much earlier than others.

For example, some companies that are in the early stages of their growth and are about to make major innovative leaps are at a historical juncture too strong to be derailed or slowed by a transient economic slowdown.

Paradoxically, these companies have been among the hardest hit by the declines of the past three to six months and are like a spring ready to snap. Their stocks on the stock market are the first to anticipate the downturns, but they are also the first to resume upward trends....

In short, from what has been said so far it is clear how the situation is in full swing and everything is proceeding by sudden turns that make the big picture more and more complex.

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