Warning of ‘earnings recession’ as markets await aggressive central bank action

A trader works on the floor of the New York Stock Exchange (NYSE) in New York City on June 13, 2022.

Brendan McDermid | Reuters

Global stock markets diverged on Tuesday after a global selloff in the previous session as analysts weighed the longevity of the bear market and the risk of a recession.

U.S. stock futures rebounded in early pre-market trading on Tuesday after the S&P 500 fell back into bearish territory the day before.

Investors await a historic monetary policy announcement from the Federal Reserve on Wednesday, with bets on an interest rate hike of 75 basis points in light of an 8.6% annual inflation shock for May. .

The prospect that the Fed and other central banks will be forced to raise interest rates more aggressively in order to rein in inflation – at a time when growth is slowing in most major economies – has reignited fears of a global recession.

Earnings recession

Guy Stear, head of emerging markets and credit research at Societe Generale, told CNBC on Tuesday that while a recession seemed more likely, there were two things to consider.

“One is the pure economic outlook, and the other is the earnings outlook. I would actually be more concerned about earnings than economic growth itself,” Stear said.

He said the more than 25-year trend of rising profits as a percentage of GDP was “more or less over,” given the lingering themes of de-globalization, rising energy and input costs and of wage increases.

“So I think whatever happens in terms of the economic outlook – and yes, the likelihood of an economic recession is increasing – the likelihood of an earnings recession is increasing much faster.”

Central banks are ‘starting to panic’

Besides the Fed, the Bank of England, the Bank of Japan and the Swiss National Bank are expected to announce monetary policy decisions this week. Each faces its own set of economic challenges, as well as the global issues of soaring food and energy prices and supply chain disruptions.

“What we’re seeing right now is central banks are starting to panic, markets are clearly facing all of a sudden this new era of higher interest rates, so we have this big stock market correction I think rightly so,” said Carsten Brzeski, global macro head at ING.

“With central banks now tightening monetary policy, in some panicked fashion, the likelihood of a recession in the US, but also in the Eurozone towards the end of the year, has clearly increased.”

Wall Street’s overnight losses rippled through Asia-Pacific markets on Tuesday, with major exchanges down sharply and Australia’s S&P/ASX 200 plunging more than 3.5% as it returned to trading after a holiday. European markets were choppy on Tuesday as the Stoxx 600 index jumped 1% in early trading, before falling back to the flat line about an hour later.

Be on the defensive

In terms of positioning in response to the current pullback, Soc Gen’s Stear suggested that several defensive areas of the corporate credit market could offer some protection for investors.

“My personal view in terms of where we are in the bear market is that we’re about three-fifths into credit markets, so I’m looking for another 80 basis point widening in terms of credit, which means probably not double digit losses, but close to, in equity markets before I really start looking at valuations,” he said.

In particular, Stear identified energy and utilities, as the latter represent a necessity in the transition to clean energy and the green transition. However, he also remains positive on the banking sector.

“I think the banks have deleveraged so much over the last 10 years that they are much less sensitive to economic variations, especially in Europe, than they would have been 10, 15, 20 years ago, so I think it’s more of a defensive business than people realize,” Stear said.

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