These 5 bearish arguments have yet to derail the stock market rally
10 Aug 2023
There are five major bearish arguments for an imminent recession and a falling stock market.
So far, all of these arguments have fallen flat, according to market veteran Ed Yardeni.
Here's why each of the bearish arguments have yet to put a dent in the stock market rally.
The stock market has staged an impressive rally so far this year as a much-feared recession appears further out than most initially expected.
The S&P 500 and Nasdaq 100 have both entered a bull market earlier this year and are up 17% and 39% year-to-date, respectively.
According to Wednesday note from market veteran Ed Yardeni, all of the bearish arguments supporting a stock market sell-off and eventual recession have fallen flat, and that means there could be more gains ahead. Yardeni expects the S&P 500 to trade to 5,400 by the end of 2024, suggesting potential upside of 20%.
These are the five bearish arguments for the stock market, and why they haven't yet derailed the current rally, according to Yardeni.
1. Leading economic indicators are falling
The Index of Leading Economic Indicators (LEI) peaked in December 2021 and is down 9.4% since then through May, Yardeni highlighted. Prior declines in the LEI have correctly anticipated the previous eight recessions with an average lead time of about 12 months.
But according to Yardeni, the LEI is biased towards the manufacturing sectors of the economy relative to the services sectors. Recent readings in the LEI are "consistent with our rolling recession scenario, with the recession currently rolling through the goods sector. That's confirmed by the weakness in the ATA truck tonnage index and railcar loadings of intermodal containers over the past year," Yardeni said.
2. The yield curve is inverted
"Inverted yield curves signal that investors believe that the Fed's continued tightening of monetary policy would result in a financial crisis, which could turn into an economy-wide credit crunch and recession. It is credit crunches that cause recessions, not inverted yield curves that anticipate these events," Yardeni said.
"This time, the yield curve inverted last summer. It once again correctly anticipated a banking crisis, which occurred in March. What is different this time, so far, is that the Fed responded very quickly with an emergency bank liquidity facility, which has worked to avert an economy-wide run on the banks and a credit crunch, so far," Yardeni said.
3. A decline in money supply
Bearish investors have been warning about the ongoing weakness in M2 money supply, which confirms that monetary policy is tight enough to cause a recession. But despite the 4% decline in M2 money supply over the past year, it still remains about $2 trillion above its pre-pandemic uptrend, according to Yardeni.
"Demand deposits in M2 totaled $5.0 trillion during May. We reckon that's $1.5 trillion above the pre-pandemic trendline in deposits. Demand deposits currently account for 24% of M2, up from 10.3% during January 2020. M2 hasn't been this liquid since September 1972!" Yardeni said.
4. Consumers are running out of excess savings
Consumers have been spending down their excess savings from the pandemic, with some banks estimating that their excess savings will be completely wiped out by the end of the year. But Yardeni is a bit more bullish on that scenario.
"The yearly change in M2 has been closely tracking the 12-month moving sum of personal savings, suggesting that there's still plenty of excess savings left based on our analysis of M2," Yardeni said. "This conclusion is confirmed by Fed data on the ownership of deposits plus money market funds by generation cohorts."
Yardeni estimates that excess liquid assets held by just the baby boomer generation ranged between $1 and $2 trillion at the end of the first-quarter, leaving consumers with plenty of money to spend and help prop up the economy.
5. Tightening monetary policy
"Monetary policy is restrictive, especially considering the tightening of lending standards in reaction to the March banking crisis as well as the ongoing QT program. However, tight monetary policy has been offset somewhat by very stimulative fiscal policy. In the past, fiscal stimulus usually occurred at the tail end of recessions or even once they were over. This time, plenty of fiscal stimulus has been enacted before the next recession. That's another reason why the next recession has been a no-show so far," Yardeni said.
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