Having knocked down the 4,500-point wall of the S&P 500 index in just a few sessions, Wall Street proceeds quickly towards the all-time high of January 2022. Less than 6% is needed to review that peak and, with the pace at which the index has been marching for four months, the goal could be reached by the end of August. When clients asked whether the stock would hit a new high this year, Goldman Sachs answered with a resounding yes. At the beginning of June, when the American bank had set a target of 4,500 points, not for the following month but for the end of the year, the forecast seemed optimistic. Now Goldman, faced with a stock market that only knows how to rise, completely indifferent to macroeconomic data and corporate profits, can only say with commendable realism: enjoy the rise, while it lasts. And why shouldn't it last? What obstacle could stand in the way? Maybe a new wave of shorting from the dwindling bear patrol? They have tried half a dozen times since the beginning of the year and the assault has always ended with a bloodbath and with the index finger even higher. They tried again two or three weeks ago, with the result that the forced cover-ups, as Goldman and Jpm analysts tell us, were the most violent since November 2020.
The role of the Fed
Maybe the Fed will get in the way with new interest rate hikes? What is predicted next Wednesday will probably be the last, because, with inflation plummeting to 3% (and core inflation to 4.8%), a Fed rate of 5.25-5.5% is more than appropriate. Well done to the central bank which, thanks to its monetary policy, has won the war on inflation and has skilfully prepared the ground for a soft landing of the economy. For one of those not uncommon paradoxes on the financial markets, the Fed, long reviled for its ultra-restrictive policy, such as to throw the economy into recession, has finally become a friend of Wall Street and will be even more popular when it cuts interest rates in the coming months: at least by 75 cents, as the bets at the Cme for June 2024 suggest. 2% (2% this year and 1.6% next, according to Goldman). There is no talk of a real or simply soft recession, as had been envisaged in the last 8 months and even the few remaining pessimists (Bloomberg and BofA analysts) have to admit that, in the worst-case scenario, any recession would be much less severe than expected.
What is the outlook for the recession?
What happened? Despite the lackluster economic data, the economy is holding up much better than previously thought. But which data? In an editorial by Wall Street Journal of July 14, James Mackintosh argues that economists are in a state of total confusion, unable to predict the direction of the economy and the markets, as if we are living in strange times, at least unusual. Is it true that many things are different this time around? Let's take, for example, the yield curve and in particular the difference between the yield on the 10-year Treasury and the three-month one: with a gap of almost two percentage points, as never seen in the last 40 years, one would say that the prospect of a recession is more than certain. But Wall Street has a completely different opinion. There are other reasons for confusion. While building permits and new home starts have shrunk to levels that in another era would have signaled a recession, total housing spending soared to new highs. And, while the indicators of the manufacturing sector (Ism or Pmi) signal a strong contraction, those of the services indicate a robust expansion. It is true that the manufacturing sector weighs less and less on GDP, but such a contrasting trend is completely new. Furthermore, the Conference Board's Leading Indicator (a set of economic and financial indicators) points to an almost certain recession; but the coincident one shows a much rosier present condition, with a trend that from 2021 diverges from the first as never seen in the past.
Because profits have grown more in the past
Precisely this observation touches on the main reason for confusion: the dichotomy between soft (forecast, built mostly on surveys) and hard (contextual, on real data) indicators. If we believe the former, things look very unflattering; for the second everything goes well. The trend of the two curves begins to diverge towards the end of 2021, with real data constantly better than expected. Spencer Hill, economist at Goldman Sachs, has calculated that the margin of error in professional estimates of GDP doubled compared to the years before the pandemic and the explanation would lie in the depressed mood of economists. There is yet another interpretation, and one fresh analysis from the Fed suggests. Michael Smolyansky argues that low interest rates between 1989 and 2019, coupled with tax cuts, contributed more than 40% to the real growth in corporate profits and explain the entire jump in the stock price-to-earnings ratio. In the coming years, conclusions, profits and stock market valuations will grow at a much slower pace than in the past. The analysis stops at the year preceding the pandemic. After 2020, a set of unusual monetary and above all fiscal policies (subsidies) drugged the economy and profoundly altered the behavior of operators and consumers. But these stimuli are running out and, in the words of Milton Friedman, there are no free lunches in the economy.