A recession is “on our doorstep,” but investors are falling into a goldilocks scenario, says Wells Fargo. It’s “not going to end well”

Wall Street’s repeated recession warnings are starting to lose their bite. After more than a year of consistent doomsday forecasts, the US economy has remained resilient in the face of persistent inflation, with the unemployment rate remaining near pre-pandemic lows and GDP growth continuing. The stock market has also rebounded from a dismal 2022, with the S&P jumping almost 16% since the start of the year.

Still, Darrel Cronk, president of the Wells Fargo Investment Institute, says the evidence remains overwhelming that a “recession is upon us.”

“Much of the manufacturing sector of the economy is already in recessionary territory,” Cronk told reporters during a mid-year outlook presentation this week, pointing to the ISM manufacturing index, which showed the sector contracted for the seventh consecutive month in May.

He noted that leading economic indicators have also been steadily declining for more than a year and are “at levels consistent with past recessionary cycles.” In his view, the Conference Board’s Leading Economic Indicators Index, which looks at data such as building permits, average weekly hours worked and new orders from manufacturers to get a sense of the health of the economy, fell for 13 straight months through April. Justyna Zabinska-La Monica, senior director of business cycle indicators at the Conference Board, said the data signaled “a deteriorating economic outlook”, noting that “weaknesses in underlying components were widespread”.

Cronk admitted that the labor market has held up this year and that the service sector of the economy has remained “somewhat strong” due to savings accumulated by consumers during the pandemic, but he said he always feared that the worst was yet to come for the economy. And Sameer Samana, senior equity strategist at the Wells Fargo Institute, argued that investors weren’t properly pricing this still-bleak economic outlook amid excitement over the latest developments in artificial intelligence and technology. fall in inflation.

“It’s the real dichotomy right now,” he explained during the mid-year outlook presentation. “The market seems to be pricing in a very rosy scenario…and we just don’t think it’s going to end that well.”

Prize for Perfection

Inflation remains well above the Federal Reserve’s 2% target; Fed Chairman Jerome Powell has warned that more interest rate hikes are on the way this year; and corporate earnings have been falling since the second quarter of 2022. But despite the warning signs, investors are still willing to pay a pretty penny for stocks, pushing stocks to valuations well above historical norms while throughout the year. Samana believes this could be a mistake due to the ongoing “earnings recession”.

The strategist noted that corporate revenues have been falling for the past few quarters because “parts of the economy are already in recession”, and on top of that the stronger than expected job market has left many companies with costs. “tights”.

“So what we’re noticing is margins are deteriorating, basically revenue is going down faster than sticky labor costs,” he said. As a recession hits the economy later this year, slowing corporate revenue growth and combining with higher labor costs to hurt earnings, Samana thinks the S&P 500 will fall around 7% from its current level at 4,100.

Still, there’s a reason so many investors have become increasingly optimistic lately. With year-over-year inflation falling from a four-decade high of 9.1% in June 2022 to just 4% in May, consumers are becoming more optimistic.

The University of Michigan consumer confidence index rose to 63.9 in June from 59.2 last month, beating economists’ consensus expectations and pushing the index to its highest level since February. And long-term inflation expectations also fell slightly from 3.1% to 3.0%, a positive sign for economists who feared that inflation expectations were becoming “entrenched” and keeping prices high. .

Some analysts also believe AI represents an $800 billion opportunity for tech companies alone this decade. Wedbush’s Dan Ives has repeatedly argued that the AI ​​”gold rush” has just begun, comparing it to the start of the dot-com bubble that began to inflate in 1995. And Tom Lee, co-founder of Equity research firm Fundstrat Global Advisors, which is known as Wall Street’s biggest bull, said earlier this week it believed the economy was sliding into an “expand” rather than a recession as inflation subsides and the Federal Reserve ends its cycle of raising interest rates.

For Samana, however, the risk may not be worth the reward. The strategist noted that the S&P 500 is currently trading at 20 times its highest earnings of last year, despite a recent contraction in earnings.

“We are going to be in a very volatile environment, with higher inflation and high rates where the Fed may or may not have finished [with interest rate hikes] and there’s a fair amount of uncertainty to go with it. You probably don’t want to pay such high earnings multiples in this environment,” he said. “I don’t think we’re going to take off to the top.”

This story was originally featured on Fortune.com

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