What the growing likelihood of “growth scare” means for the stock market, according to Citigroup


Recession concerns are being felt in equities, according to Citigroup.

A “mild recession in 2023” could send the S&P 500 index down about 20% from its late-March high of around 4,600, Citigroup analysts said in a research report Monday. Amid ‘worse macro growth scare’, the index could see a drop of around 30% as the Federal Reserve continues to tighten monetary policy in an already weakened economy to avoid high inflation and persistent, according to the report.

“Recession risks are more limited in 2022 but increase significantly through mid to late 2023,” Citi analysts said. “Stock markets have already started to price this in, but we expect the fallout to be felt primarily” in the first half of next year, they wrote.

Related: Goldman Sachs sees risk of US economy stumbling into recession over next 24 months

The S&P 500 SPX,
was down on Monday afternoon to around 4,385, as corporate earnings season for the first quarter is in full swing this week. So far this year, the benchmark US equity index has fallen about 8%, according to FactSet data.

S&P 500 earnings would take a 10% “hit” in 2023 in Citi’s “baseline recession scenario”, with the index falling about 20% to around 3,650, according to the research report. More severe recessions resulted in an average 15% drop in earnings per share, the report said.

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“Investor jitters in the early stages of a recession typically lead to multiple devaluation in the 2-3 turn range,” the analysts wrote, referring to a drop in the S&P 500’s price-earnings ratio. occurs when the Fed’s policy path deviates from the macro growth backdrop,” meaning the central bank continues to tighten monetary policy as “growth turns negative,” Citi analysts said. “It could take another 1-2 turns of the S&P 500 P/E ratio,” they wrote.

The Fed has tightened policy by raising interest rates while planning to shrink its balance sheet as it aims to cool the economy to bring down high inflation in the United States.

Traditionally defensive sectors, such as utilities, SP500EW.55,
SP500EW.35 Consumer Staples, Real Estate, Communication Services and Healthcare,
become attractive to investors worried about a recession because their incomes are “less sensitive to economic activity,” according to the report.

But these sectors represent only 35% to 40% of the S&P 500 index, according to analysts. “There’s not enough market capitalization in defensive sectors to build a recession-proof portfolio.”

In a “mild recession scenario, growth could also prove defensive, making the technology relatively attractive,” they said. “However, a deeper pullback with further rate hikes is likely to put pressure on several higher bands, signifying a quality overlay” in cyclical areas such as Materials, Financials SP500EW.40,
“and even the industrial SP500EW.20,
should make sense,” analysts say.

Amid concerns over rising interest rates, RLG growth stocks,
lagged RLV value stocks,
this year by a wide margin, according to FactSet data.

In recent weeks, investors have often asked Citi analysts how paper and packaging stocks would fare in the event of a recession or a “sharp market correction,” according to the report. “Our analysis suggests that packaging is a relatively safe place for investors,” they said, “much better than paper.”

In their report, Citi analysts speculated that “equity markets have begun to more meaningfully price the likelihood of a year-on-year recession around late-March highs as U.S. yield curve inversions are emerged and expectations of a possible reduction in monetary policy from the Fed made their way into the fed funds. futures markets. At that time, “the S&P 500 was trading around 4600,” they said.

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A closely watched part of the Treasury market yield curve briefly inverted during trading late last month and closed in an inversion At the beginning of Aprilwhich means that the 2-year yields have exceeded those of the 10-year Treasury note.

The last time 2- and 10-year Treasury yields reversed was in 2019, according to Dow Jones Market Data. An inversion of this part of the Treasury market yield curve has historically preceded a recession, although typically a year or more before an economic contraction.

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Also see: Why an inverted yield curve is a bad tool for timing the stock market

This part of the yield curve is no longer inverted, however, with the yield of the 10-year Treasury note TMUBMUSD10Y,
trading at 2.86% on Monday afternoon, putting it above the yield of the TMUBMUSD02Y 2-year Treasury note,
around 2.47%, according to FactSet data, when last checked.

The probability of a recession over the next year is 20%, up from 9% at the end of February, according to the Citi report.

“Investors are seeing the growing odds of a macro growth scare over the next 12 to 18 months,” Citi analysts said. “Compared to previous recessions,” they expect the stock market response “to be earlier in and out.”

All three major US stock indexes have sunk this year, including the S&P 500, the Dow Jones Industrial Average DJIA,
and the Nasdaq Composite. The technology-rich Nasdaq COMP,
saw the steepest fall yet in 2022, falling around 15% based on Monday afternoon trading, amid fears that rising rates could hurt equity valuations in particular high-flying and fast-growing.


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