Stock market investors are waiting and hoping for a turn for the better, but a stubborn market just won’t cooperate.
Take the S&P 500, which fell by about 1% over the past 90 days. That’s not going to cut it with weary investors.
Certainly, investors face a stacked menu of issues that threaten the stock market in the second half of 2023. Those include ongoing high inflation, pressure on regional banks, receding consumer demand, an earnings slide across multiple business sectors, looming recessionary clouds, and a congressional standoff over the U.S. debt ceiling.
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All of the above are in the minds of professional stock market trackers.
Noted market bear Jeremy Grantham, for example, sees a market bubble fueled by expanding pressure on the U.S. banking sector. Grantham, the co-founder of the investment firm GMO, famously called the 2000 dot-com crash. Now he sees a similar market outcome for the second half of the year — and what he sees isn’t pretty.
“Other things will break, and who knows what they will be,” Grantham told CNN on April 13. “We’re by no means finished with the stress to the financial system.”
The “best we can hope for” is a 27% decline from current levels and the worst-case scenario would be a 50% slide in market prices, according to Grantham. He says the fall could be lengthy, too, as he doesn’t see the market hitting bottom until “deep into next year.”
Not every market tracker is as pessimistic.
JPMorgan sees the near-term market continuing to fall but does predict a rebound in the second half of the year.
“In the first half of 2023, the S&P 500 is expected to re-test the lows of 2022, but a pivot from the Federal Reserve could drive an asset recovery later in the year, pushing the S&P 500 to 4,200 by year-end,” the investment bank said in a research note.
What specific issues will impact the U.S. stock market going forward? Here’s a snapshot of seven potential red flags that could drive the market into negative territory:
— High inflation.
— The debt-ceiling crisis.
— Recession.
— Rising interest rates.
— Tepid earnings.
— Weakening regional banks.
— Supply chain disruption.
High Inflation
In April 2023, the annual U.S. inflation rate stood at 4.9% year over year, which is down from 6% in February. While the numbers are moving in the right direction, inflation still represents a huge threat to the U.S. economy and to the stock market.
In early May, the Federal Reserve boosted interest rates by 25 basis points to a target range of between 5% and 5.25%. The rate hike was the 10th consecutive rate increase in a little over a year, signaling that the Fed still takes inflation seriously and may keep boosting rates — possibly as soon as June — to keep inflation in check.
“The (Federal Reserve Open Market) Committee anticipates that some additional policy firming may be appropriate” to ensure that the Fed reaches its objective of a 2% U.S. inflation rate, the Fed reported on May 3.
Consequently, with regulators still in rate-hike mode, the stock market remains constrained by higher borrowing costs and squeezed consumer and corporate budgets.
The Debt-Ceiling Crisis
With yet another debt-ceiling confrontation between House Republicans and the White House, investors can only watch and wait to see how debt-ceiling negotiations will affect the stock market.
The federal debt-ceiling issue is so incendiary that U.S. Treasury Secretary Janet Yellen sent a letter to Congress on May 1 stating, “Our best estimate is that we will be unable to continue to satisfy all of the government’s obligations by early June, and potentially as early as June 1, if Congress does not raise or suspend the debt limit before that time.”
How did the U.S. get to this point on its debt obligations? As usual, politics plays a significant role.
“Financial markets have taken previous close shaves on the debt limit in stride, but market participants are seeing greater political intransigence this time around, with both sides digging in their heels,” said John Canavan, lead analyst at Oxford Economics, in a report on May 8.
The ongoing political battle could fuel tough economic times for the U.S. public and for the stock market, leading to high interest rates and a stalled economy — neither of which are good for the financial markets.
Recession
Economists are swirling their crystal balls and they don’t like what they see when the smoke clears.
The chief economist at Russell Investments says a mild recession is likely over the next 12 to 18 months, and that’s toxic news for the investor class.
“The inverted yield curve is the indicator that most clearly signals recession risk,” says Andrew Pease, global head of investment strategy at Russell Investments. Pease cites an alarming spread between the 10-year and 2-year Treasury yields right now: “A negative spread (inversion) means that bond investors think the Fed has tightened by so much that interest rates will be lower in the future.”
The damage may be muted by robust household and corporate finances, but that won’t help stock market investors, Pease says.
“A mild recession, however, implies that the cycle will be a headwind for equity markets as earnings and economic indicators deteriorate. It is a more favorable environment for government bonds, which should provide investors with good diversification potential,” he adds.
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Rising Interest Rates
The Federal Reserve has continued on its inflation-fighting path with more interest rate hikes in early 2023 — and it may not be done yet. Ongoing rate hikes could crimp stock market performance as higher rates make it more difficult for consumers and businesses to buy goods and services.
According to a new study from WalletHub, after the Fed’s most recent quarter-point rate hike, U.S. credit card consumers as a whole can expect to pay an extra $1.7 billion in interest charges over the next year. Similarly, a quarter-point rate hike costs mortgage borrowers about $11,160 on a 30-year home loan of $437,700 over the life of the loan, analysts estimate.
Tepid Earnings
Publicly traded companies continue to see a slide in revenues in the second quarter of 2023. The larger question is how long it will take for earnings to recover.
FactSet Research Systems estimates that S&P 500 second-quarter earnings will decline by 6.3%, and revenue will fall by 0.4%.
“Corporate earnings are another watchpoint for investors this year,” Pease says. “Earnings growth peaked in most regions in early 2022 and has trended lower since. This has in part been due to moderating sales growth as economic growth cools, but falling margins have also played a role. Margins were boosted by rising inflation during 2021 and early 2022 as final pricing power improved, but cost inflation, particularly labor costs, remained subdued.”
Going forward, positive economic data “could see earnings growth expectations track broadly sideways for the next few months,” Pease adds. “A further downturn in earnings expectations seems likely, however, as the Fed achieves its goal of reducing inflation by slowing demand.”
Weakening Regional Banks
While the March 2023 banking crisis involving Silicon Valley Bank, Signature Bank, Credit Suisse Group AG and First Republic Bank, among others, seems to be fading in the rearview mirror, Wall Street analysts say the financial sector is hardly out of the woods yet.
“It’s been a robust response (to the banking crisis), which should help settle investors’ nerves,” say Daniel Casali and Rob Clarry in a recent research note published by Evelyn Partners. “However, there are arguments against this being an isolated event.”
They add that significant unrealized losses at smaller U.S. commercial banks remain. “It is not yet clear whether they have hedged these risks and whether they will be forced to divest assets (and crystallize losses),” say Casali and Clarry. “Equally, there may be other sources of stress in the system that have not yet been uncovered.”
Evelyn analysts see a “midway scenario” for struggling banks going forward.
“We have already seen a fall in bank lending over recent months. As risk aversion and regulatory scrutiny of small banks increases, aggregate lending is likely to fall,” they say. This could affect economic activity and lead to more defaults and further tightening of lending conditions, and even threaten the stability of the financial system, the analysts project.
“If it reaches this point, central banks and financial regulators would step in,” they say.
Supply Chain Disruption
While the supply chain scenario has moderately improved in the first two quarters of 2023, there’s still a long way to go, experts say.
“While we continue to see improvement in our supply chain, we will see ongoing challenges and pressures across all core markets we serve,” notes Border States in its most recent global supply chain update. “We believe that it will be years before the supply chain fully stabilizes, and we may never fully return to the ‘just in time’ world seen prior to the pandemic.”
Border States, a major electrical products and services distributor, also says that most global commodities have shown “signs of softening.”
“Continued volatility and unpredictability is expected,” the company says.
When supply chains are constricted and inventories thin out, companies are forced to raise prices to cope with the problem. That leads to more inflation and weaker company performance, which stock market investors typically don’t want to see.
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Update 05/17/23: This story was previously published at an earlier date and has been updated with new information.
