- Investors are facing mixed signals from a cooling economy and expectations for continued corporate earnings growth.
- A surprise surge in unemployment has raised recession fears, but they might be unfounded.
- The overall direction of the stock market hinges on how resilient corporate earnings growth will be.
Markets are digesting mixed signals that will likely be the driving forces of stock performance for the remainder of 2024.
On the one hand, investors are eyeing a cooling economy, with the recent uptick in the unemployment rate sparking a fresh wave of fears that the US is on the verge of a recession. Opposite that force is Wall Street's continued expectation that earnings growth will remain steady, driving further stock gains.
"While the market focus in 1H was largely tied to the path of inflation, 2H focus is quickly turning to growth risks given elevated earnings expectations for 2H24 (+9%) and 2025 (+14%)," JPMorgan analysts wrote in a note on Thursday.
They say that the market dynamic is now centered on a "two-sided debate," with risks to economic growth and rich stock valuations top of mind.
A surprise surge in the unemployment rate last week, the triggering of the Sahm Rule recession indicator, and a Federal Reserve that has kept monetary policy in restrictive territory for potentially too long, have amplified investors' concerns that a recession is around the corner.
That would likely come with a massive decline in stock prices, a preview of which was on full display earlier this week when the Nasdaq 100 extended its monthlong decline to more than 10%, and some mega-cap tech shares experienced double-digit percentage declines in a single day.
"The current market pullback, in our view, was primarily driven by fears tied to weakening growth and the repricing of recession probabilities," the JPMorgan strategists wrote.
This week, the bank increased its probability of a recession by the end of the year to 35% from 25%, while Goldman Sachs boosted its recession probability to 25% from 15%.
The stock market is still at risk of further downside, as valuations remain elevated and the Fed shows little urgency in cutting interest rates, analysts note.
"While the recent market flush took out some of the froth, equity positioning and valuation still remain at risk especially if growth continues to decelerate and the Fed does not show urgency," JPMorgan said.
But while the US economy appears to be slowing, corporate earnings are still growing, which should help put a floor under stock prices, and could even supply them with more fuel to rise further.
Of the 88% of S&P 500 companies that have reported second-quarter earnings results so far, 79% of those beat profit estimates by a median of 6%.
On a year-over-year basis, earnings are up nearly 12%, well ahead of expectations for 9% growth just a few weeks ago.
What's more, forward earnings expectations hit an all-time high last month, according to data from Yardeni Research.
The stark juxtaposition between fears of an imminent recession and a potential slowdown in the stock market, even as corporate earnings surge, has been on display.
Google search trends for the word "recession" have hit their highest level since June 2022, when soaring inflation and aggressive interest-rate hikes had investors concerned about an economic slowdown.
At the same time, mentions of an economic downturn on corporate earnings calls have dropped to their lowest level since the third-quarter of 2022, according to data from Bloomberg.
"The S&P 500 is 10.5% higher [year-to-date]. We expect some sideways chop over the coming months and are mindful of looming risks in the Middle East, but we remain positive on US economic growth and on US equities," Ed Yardeni of Yardeni Research said in a note to clients earlier this week.
The JPMorgan analysts note that a final wild card for investors to consider is the newly injected uncertainty around the election following Kamala Harris's rise as the presumptive Democratic nominee.
"[H]er late introduction into the Presidential race presents an additional hurdle for investors in terms of pricing election risk later this year as the gap between both candidates has closed and final policy platforms of both remain uncertain," the analysts wrote.