July 19, 2024

Summer Market Blues: Will Stocks Weather the Economic Storm?

Stocks struggled at the beginning of June, prompting concerns about potential market difficulties in the coming summer months. Despite the recent strength in both the U.S. economy and the stock market, a group of strategists is sounding alarms over emerging warning signs that could spell trouble for future growth.

Tom Essaye, founder of Sevens Report, expresses growing concern over an unforeseen economic slowdown, which he believes could trigger a significant correction in the stock market. While corporate profits have appeared strong, Essaye attributes this more to companies’ cost control measures than genuine demand. He highlights that consumers are becoming more selective, negatively impacting various industries, including tech, retail, Workday (WDAY), American Airlines Group (AAL), and Lululemon Athletica (LULU).

In this climate, where investors eagerly anticipate Federal Reserve rate cuts, some interpret bad news as good, believing it will push the Fed to lower rates. However, Essaye warns that such a perspective is overly simplistic. He notes from experience that cheering a slowdown has not always led to timely rate cuts to avert broader economic downturns. “Twice in my career I have seen investors cheer a slowdown, and both times the Fed was not able to cut rates at the right time to prevent the slowing from becoming a broader economic contraction,” Essaye writes, emphasizing that catching a falling knife is risky in both real life and stock trading.

Andrew Brenner, head of international fixed income at National Alliance Securities, shares similar concerns, suggesting the Fed’s focus on inflation might be causing it to overlook signs of economic weakening. Brenner points to declining consumer confidence and inflation-adjusted spending as evidence that the U.S. economy is slowing down, albeit not to recessionary levels.

These cautionary voices align with recent warnings highlighted by Barron’s, suggesting that the market could face turbulence this summer due to high interest rates and Treasury yields. This contrasts with the market’s performance over the past year. Despite a challenging April and a downbeat end to May, the S&P 500 rose nearly 5% last month and more than 10% year-to-date.

Citigroup strategist Scott Chronert suggests that if the S&P 500 were valued purely on macroeconomic trends, it would be appropriately priced at around 4000, significantly below its current level just under 5300. However, Chronert argues that the S&P 500 (Wall Street) is not in sync with the broader U.S. and global economy (Main Street). He points out that the correlation between S&P 500 earnings and gross domestic product has decreased. Today, technology-driven productivity gains and the rapid integration of artificial intelligence across industries are poised to drive earnings growth, supporting higher valuations.

Chronert believes that these structural tailwinds could see the S&P 500 trading between 5500 and 6200, as they contribute to increased through-cycle profitability, which supports higher valuations. Similarly, despite his concerns, Essaye acknowledges the potential for the S&P 500 to reach 5700 or higher if yields ease and investors focus on 2025 earnings projections, expected to rise to $270 per share from $243 this year.

Historically, the market has managed to rally despite adverse signals, so further gains amid deteriorating conditions are not impossible. However, if stocks experience a summer slump, weak economic data will likely hinder their ability to rebound.

Key Takeaways

  1. Stocks began June with volatility, hinting at potential challenges ahead.
  2. Concerns about an unexpected economic slowdown could lead to a significant market correction.
  3. Corporate profits have been sustained more by cost control than by strong demand.
  4. The Federal Reserve’s rate cut expectations might not materialize as hoped.
  5. Despite mixed economic indicators, structural factors like technology and AI integration could drive earnings growth and support higher market valuations.

Conclusion

The stock market faces a precarious balance as it navigates potential economic slowdowns, Federal Reserve policies, and structural growth drivers. While some analysts are cautious about the near-term outlook, others see opportunities for continued growth driven by technological advancements. Investors should remain vigilant and consider both the warning signs and the potential for long-term profitability gains when making investment decisions.

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