Stock Market Could Crash Another 20% If U.S. Plunges Into Recession

As a growing number of investment banks and company chiefs warn that the likelihood of a recession is increasing, analysts at Morgan Stanley are telling clients that the stock market—despite reeling from a steep selloff in recent weeks—has plenty of room to fall before hitting levels consistent with recession-era lows, which would be especially bad for cyclical industries like travel and hospitality.

Despite major stock indexes plunging more than 20% below recent highs, markets are still only down by about 60% of the average drawdown compared with previous recessions (which denote two consecutive quarters of negative GDP growth), Morgan Stanley analysts told clients in a Tuesday note.

As the Federal Reserve works to combat decades-high inflation with interest rate hikes that will likely stunt economic growth, a recession “is no longer just a tail risk,” analysts led by Michael Wilson wrote, putting the odds of one over the next year at 35%, up from 20% in March.

They estimate the S&P 500 could plunge as much as 20% to 3,000 points, from current levels of 3,770, if the U.S. falls into recession, citing earnings that tend to fall an average of 14% during recessions—a marked turnaround from record profits and 25% growth last year.

“The bear market will not be over until recession arrives—or the risk of one is extinguished,” the analysts said, adding that market weakness will likely continue over the next three to six months in the face of “very stubborn” inflation readings.

With high prices deterring some consumer spending, Morgan Stanley says stocks tied to discretionary spending, like those in retail, hotels, restaurants and clothing, are at higher risk of a downturn, while those tied to the internet, payments and durable household goods (like appliances and computers) are less at risk.

The note comes the same day Tesla CEO Elon Musk said the U.S. economy will “more likely than not” face a recession in the near term, echoing concerns raised by several other top business leaders and financial institutions following last week’s steeper-than-expected hike in key interest rates, which tend to deter spending by making borrowing more expensive.

Morgan Stanley’s not alone in raising recession odds this week. In a note to clients Monday, Goldman Sachs’ chief economist, Jan Hatzius, said the firm now sees “recession risk as higher and more front-loaded,” given the Fed’s more aggressive rate hike, putting the odds of a recession over the next two years at 48%, up from 35% previously. The investment bank estimates tighter financial conditions could drag down GDP as much as 2 percentage points over the next year.

Restaurants are most at risk of a pullback in spending, according to a Morgan Stanley survey of some 2,000 consumers. Roughly 75% of respondents said they’ll cut back on dining out over the next six months, while 60% said they’d do so on deliveries and takeout from restaurants. Though driving much of the inflationary gains, essential items like gas and groceries should see more resilient spending, with roughly 40% of consumers saying they’d cut back on either.

Major stock indexes plunged into bear market territory last week ahead of the Fed’s largest interest rate hike in 28 years, and the gloomy sentiment has ushered in waves of layoffs among recently booming technology and real estate companies. “We don’t believe the Fed can stop the issues that are causing inflation on the supply side without absolutely wrecking the economy, but at this point, it looks like they are resigned to the fact that it must be done,” says Brett Ewing, chief market strategist of First Franklin Financial Services. Goldman Sachs has warned clients it expects another 75-basis-point hike in July.

I’m a senior reporter at Forbes focusing on markets and finance. I graduated from the University of North Carolina at Chapel Hill

Source: Stock Market Could Crash Another 20% If U.S. Plunges Into Recession—These Industries Are Most At Risk

The best hope for stocks right now is a recession that crushes inflation and allows the Fed to slow, stop or even reverse rate hikes.

Why it matters: Down 20.5% so far in 2022, it’s the ugliest year for the S&P since 1962. The drop vaporized $9 trillion in paper wealth, delivering a psychological shock to millions whose retirement is mostly in stocks.

Driving the news: Facing persistent inflation, the Fed delivered its largest rate hike since 1994 on Wednesday.

  • The increase is the monetary-policy equivalent of stomping on the country’s economic brakes — sharply increasing the risk that growth contracts.
  • Despite the recent beating shares have taken, the Fed’s announcement was greeted with open arms by investors. The S&P 500 rose 1.5%. The Nasdaq rose 2.5%. Interestingly, the Russell 2000 — which is more closely tied to short-term ups and downs of the economy — rose less, at just 1.4%.

The big picture: A huge rate hike that raises the risk of recession may sound like a bad thing for stocks — but with inflation still rising, it isn’t.

  • Essentially, investors are saying they prefer a big, sharp Fed-induced economic shock now if it quickly gets inflation under control. In theory, that could allow lower rates to return after inflation is vanquished.
  • Low interest rates have been crucial to the performance of stocks over the last decade.

Context: While Americans have a habit of looking at the stock market as an economic indicator, the linkage between economic growth and stock market performance is surprisingly weak, and, some academics say, nonexistent. The most extreme example of this reality arose during the bleakest moments of the COVID-related recession.

  • In April 2020, the U.S. economy was essentially on life support. Unemployment that month was 14.7%. There were, quite literally, bread lines miles long.
  • That month the S&P 500 posted its best month in 33 years, rising nearly 13%.

What gives? Well, in late March 2020, the Federal Reserve had to cut interest rates to zero and restart money-printing programs do deal with the COVID crisis. (The Federal government also began dumping what would ultimately be trillions of dollars into the economy to keep people afloat.)

The intrigue: But don’t recessions hurt corporate earnings? Wouldn’t that make stocks fall?

  • Earnings are one ingredient in stock prices, and they can definitely fall during recessions. But recently, interest rates — essentially the yield on the 10-year Treasury note — have played a more important role in establishing stock prices than earnings.
  • That’s because those interest rates largely determine the valuation multiple — otherwise known as a price-to-earnings ratio — investors use to determine the price they’re willing to pay for those future earnings (effectively, the price of a stock).
  • TL;DR: Higher rates = lower valuations, and vice versa.
  • So, even if earnings are expected to fall, stock prices can still rise, if valuations rise enough. Those valuations are largely determined by interest rates — and those rates are largely determined by Fed decisions.

The Federal Reserve made an aggressive new move in its campaign to bring down inflation Wednesday, raising its target interest rate by three-quarters of a percentage point, the steepest rate hike since 1994 — and indicated another similar move could be coming next month.

Driving the news: In addition to increasing their target for short-term interest rates to a range of between 1.5% and 1.75% Fed officials projected that their target rate will reach 3.4% late this year, far higher than the 1.9% they envisioned in March. Mortgages, car loans and credit card debt are all about to get more expensive.

Yields on U.S. government bonds — known as Treasuries — rocketed in recent days, as Friday’s inflation report convinced many that a combination of persistently high inflation and aggressive Federal Reserve interest hikes, is on the way. The yield on the 10-year Treasury note surged to nearly 3.50% in recent days, a level not seen since 2011……

  Matt Phillips

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How Do Experts Know The Causes Behind The Stock Market’s Ups and Downs


Listener Katy Davis asks:

When reporters say, “The markets are down today based on XX,” sometimes it is something really obvious like a recent jobs report or a surprising boost to the economy. But sometimes it is something that seems so vague, like “based on fears about the situation in Greece.” Anyway, how do they know that? Are they calling traders and asking? Guessing? How can an entire day of trading be summed up like that? 

Sometimes the experts actually don’t know for sure. When asked how confident he is about his assessments, Commonwealth Financial Network’s chief investment officer, Brad McMillan, said:

“Not very. At the end of the day, this is an almost infinitely complex system.”

Some days, the drivers are more obvious than others, with news items like, yes, a recent jobs report. The Russia-Ukraine war. Or inflation numbers, like we saw Friday. The prices of consumer goods jumped 8.6% year over year in May, the highest rate since 1981. That showed inflation hasn’t slowed down, and it sent the Dow Jones Industrial Average plunging almost 900 points. 

McMillan, who writes a Commonwealth blog, said you can draw a direct link between market movements and anything that “materially either changes or directly confirms expectations.” But it can get complicated. McMillan said he’ll look at various investment commentators’ second and third reactions to news that happened earlier in the week.

“For example, if the [Federal Reserve] raises rates, the initial reaction might well be, ‘Oh, my goodness, rates are higher. That’s bad for stocks,” he said.  But in the following days, the reaction might become: “If they raise rates, in the short term, that might increase the probability they’re gonna have to cut rates in the longer term. So on balance, that can be positive,” McMillan said.

There are multiple events happening at a given time, and McMillan has to parse which factors may be the most important. So right now, he’s paying attention to interest rates.  That’s because they strongly influence stock valuations. In recent blog post, McMillan explained:

“Lower rates mean higher valuations for stocks, which explains the market rally we saw during and after the pandemic, as rates were cut to zero and stocks soared. With rates rising again as the Fed tightens policy, we are seeing valuations adjust down, bringing down the market.”

There are also non-obvious factors that influence stocks, like the U.S. entering an election cycle. During years when there are midterms, McMillan said, the market performs worse. And because it’s something we expect, it can actually become a “self-fulfilling prophecy, to some extent,” he explained.

Sometimes there are factors that led to market upswings or declines that analysts hadn’t accounted for at the time. For example, analysts tend to underestimate corporate earnings growth, McMillan said.  Back in 2015, global markets suffered amid fears of a possible Greek default on the nation’s debt. Vague, as listener Katy Davis pointed out. Investors and financial experts explained to news outlets at the time that investors don’t like political risk.

John Blank, the chief equity strategist at Zacks Investment Research, delved into that problem. “Fears — of loss of capital — inside a country can be quantitatively expressed by other asset classes: by wider bond credit risk spreads, capital outflows that depreciate the domestic currency, higher lending rates, depressed activity. One would expect at least some of these to accompany a down stock market, in that case.”

Blank, who writes commentary for the firm, said analysts and experts can look at FinViz.com, a site that displays major stock indexes, stocks by market capitalization and “top gainers” or “top losers.”  Analysts can then tell how a specific sector, like health care, for instance, performed after an announcement from the government or another influential event, he explained.

Blank said sometimes it’s difficult to figure out what’s going on in the markets when there’s no obvious news that day, and an analyst might flag important upcoming news to help investors prepare.

By: Janet Nguyen

Source: How do experts know the causes behind the stock market’s ups and downs? – Marketplace

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Why All Investors Need To Own Gold and Bitcoin

I was lucky enough to find myself on GB News at the weekend, standing in for the veteran broadcaster Alastair Stewart, who was taking some no doubt well-deserved time off. No prizes for guessing what subject was the main focus of the two two-hour programmes.

The world has changed, and investors need to take that into account

There were all sorts of guests – Russian, Ukrainian, Polish – who all knew their onions, and added so many profound insights into the conflict. I sat there trying to ask sensible questions while absorbing as much information as I possibly could. I can’t pretend to be informed on this subject, despite being a lot more so now than I was a week ago – like most of us, I guess.

We covered so many subjects. The incredible bravery of the Ukrainian people and the resilience they have shown in the face of much better-armed opponents; the apparent strategic mistakes made by Russian forces so far, and the poor communication; the ruthlessness of Putin, the need to win and the risk that he doubles down.

We also covered sanctions, Swift and the weaponisation of money; the war on the oligarchs and the kleptocrats; the imminent refugee crisis; propaganda; the tacit alliance between Russia and China – and that China will be watching all of this and learning; the ramifications for Taiwan; the dependency of so many nations on Ukraine and Russia for food supplies. And much more besides. I watched, listened and tried to learn.

I left the studio with a distinct feeling of dread that this invasion may prove to be the beginning of something much bigger. Russian commentator Konstantin Kisin, who hosts the popular podcast Triggerpod, kept repeating the point that in terms of historic significance this invasion is “bigger than 9-11”. The geopolitical landscape has changed, he said, and the West is at war.

On both days, I left the studio feeling glad that I owned gold. It has been a source of immense disappointment and frustration to me, as regular readers will know, but there is a time to own gold and now would appear to be one of those times. I have reported more times than I care to remember on the vast amounts both Russia and China have accumulated over the last 20 years.

Meanwhile, the way that the West has weaponised its money and banking against Russia is extraordinary – unprecedented even, and made possible by digital banking and modern technology. China is surely looking at this weaponisation, looking at Taiwan, and thinking that to protect itself, it needs to de-dollarise as quickly and discreetly as possible. Indeed, we know China has already been doing that.

With so much money frozen abroad, one of the few ways in which Russia can actually fund itself is by selling its gold, probably via Dubai, so that may mean selling pressure. Even so, I think gold rises from here.

Hold gold, bitcoin and gold miners in the Americas

Inflation comes with war; money gets debased, no matter which side you are on. If there is some kind of China-Russia, anti-West alliance, then just as we have retaliated against Russia through Swift and the banking system, that alliance will do the same in reverse. Ergo, it will wage war on the dollar.

Western money is vulnerable. Fiat money has been printed into oblivion, while interest rates have been suppressed. Official inflation is already at 7%, while actual inflation is arguably much higher. Yet the system probably can’t take interest rates much above two or three percent. There is too much debt.

When the price of raw materials – commodities and natural resources – goes up even more because a key supplier, Russia, has been cut off, the pain of inflation is going to get worse. Governments may well attempt to impose price controls, but history shows that any relief that comes from price controls is only temporary. For the most part they don’t work and often just lead to shortages.

I’ve said for many years all China has to do is declare what its gold holdings really are – and you can see last year’s estimates here (I will do an update on this soon) – and that will be tantamount to a declaration of war. My theory, remember, is that China’s gold holdings are as big, if not bigger than those of the US.

I know I have long moaned about gold. It’s the most analogue asset there is in a world where all the value is digital. But I have also said many times that I continue to own it. It may be analogue but it has also been money since forever. It’s the first metal we ever used. 

We used it long before the Bronze Age, when we discovered smelting. Its purpose was the same as it is now – as reward, as display, as store of value, as tool of trade (in this case barter). In other words, as money.

But I have moaned about it because it has been such a perennial disappointment for so long.The currency wars are hotting up. Attacks on national currencies are going to become the norm; the rouble has been bombed already. Don’t think that at some stage the dollar, euro and the pound are not going to come under attack, because they will. Other fiat currencies will get caught in the crossfire.

Gold and bitcoin are the places to hide. On the subject of bitcoin, I see this conflict as an opportunity for it to decouple itself from the Nasdaq. If Swift is out of bounds, and governments in conflict have their tentacles running through the banking system, the use case for bitcoin suddenly got more compelling. What better way to transfer value across borders? You want to own both. And all those gold miners located far away from all of this in the Americas. There’s going to be a lot more demand for their product.

Source: Why all investors need to own gold – and bitcoin | MoneyWeek

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Best ETFs For Rising Interest Rates

ECB Warns House Price Correction Looms As Interest Rates Rise

Eurozone property prices are set to correct as interest rates begin to rise in response to higher inflation, posing greater risks for low-income households, the Bank has warned. Central European.

A reversal in the region’s housing markets was one of the main risks identified by the ECB’s biannual financial stability review, which also warned that Russia’s invasion of Ukraine meant more companies were likely to default due to weaker growth, higher inflation and rising borrowing costs. .

Anticipating that asset prices could fall further if economic growth continues to weaken or if inflation rises faster than expected, the ECB said a sharp rise in rates could cause a “reversal” in oil prices. real estate in the euro zone, which it said were already overvalued by around 15%, relative to overall economic output and rents.

The central bank is preparing to raise its deposit rate in July for the first time in a decade and markets are expecting four quarter-point hikes this year, which it says “could challenge the valuations of riskier assets, such as equities”.

Mortgage rates in the eurozone have already been rising since the start of the year. The ECB’s composite indicator of the cost of borrowing to buy a home rose from a low of 1.3% last September to 1.47% in March.

“A sharp rise in real interest rates could induce house price corrections in the near term, with the current low level of interest rates making a substantial reversal in house prices more likely,” the statement said. ECB.

House prices rose nearly 10% in the euro zone last year, the fastest rate in more than two decades, according to data from Eurostat, the statistics office of the European Commission. They could fall between 0.83 and 1.17% for every 0.1 percentage point increase in mortgage rates, after adjusting for inflation, the ECB calculated.

The Bundesbank recently warned that German banks were becoming too complacent about the risk of borrower default and the possibility of rising interest rates, increasing the amount of capital lenders must put up as collateral for their mortgages.

“We think the German real estate market should peak in the next two years, probably around 2024, although it could be much earlier if we have an interest rate shock,” said Jochen Möbert, an analyst at Deutsche Bank Research. .

Rising interest rates will likely prompt institutional investors to shift money they have put into real estate into the German bond market, Möbert said, predicting that would likely happen when Bund yields rise from 1 % currently at between 2 and 4%. .

“Rental yields are below 4% in German cities on average and in metropolises they are lower, in some cases they are even 2.5%, so once the risk-free rates reach this level, it would be logical to go back to the Bunds,” he added.

The central bank said a switch to fixed-rate mortgages would shield many households from the immediate impact of rising borrowing costs.

Wealthier households could also cushion the blow by saving less or tapping into extra savings accumulated during the coronavirus pandemic, he said. However, he warned that this would leave lower-income households “more exposed to the inflationary shock”.

The ECB said its recent “vulnerability analysis” of the banking sector had shown it was “resilient to the macroeconomic ramifications of the war in Ukraine”.

Banks accounting for more than three-quarters of the sector’s assets would maintain a Tier 1 capital ratio above 9% in its “worst case scenario”, in which the eurozone economy shrinks over the next three years, it said. said the central bank.

Rising interest rates should increase banks’ credit margins in the short term. But Luis de Guindos, vice-president of the ECB, warned that “in the medium term, the situation could be different”.

De Guindos said banks’ profit margins could be eroded by a “duration gap” between rising short-term funding costs for banks and their longer-term loans, such as mortgages, which hold rates down. down for many years.

He admitted that the ECB had been “too pessimistic” in its 2020 warning that the fallout from the pandemic could lead to a €1.4 billion increase in non-performing loans for banks, which did not unfold. materialized as bankruptcies have instead fallen thanks to massive state support.

However, he said rising inflation and rising borrowing costs could cause some companies that have already been weakened during the pandemic to default. “Perhaps the insolvencies that didn’t happen during the pandemic could, at least in part, happen now,” he added.

ECB warns that a correction of prices real estate profile with rise of interest rates

Source: ECB warns house price correction looms as interest rates rise

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