As U.S. stocks flirt with new highs and recession seems less and less likely, the hard-core stock-market bears continue to predict an array of market-tanking disasters just around the corner.
I expect the U.S. market to finish the year up 5%-10%, for three main reasons: No recession; inflation will continue to contract, and cautious investors will come into the market and push stocks higher.
Still, it is always good to understand opposite views. With that in mind, here’s a look at five major fears of the market naysayers — and why they will be wrong. Markets can correct at any time (10% decline), but another bear market (down 20%) is not likely on the horizon.
1. 2024 brings a recession: Stock markets hate recessions. So, this would be bad for bulls. It’s a little daunting that no less than seasoned market gurus Jeffery Gundlach and Bob Doll predict this outcome. Their exhibit A: The inverted Treasury yield curve — the difference between yields of 10-year
BX:TMUBMUSD10Y
and two-year
BX:TMUBMUSD02Y
U.S. Treasurys , which invariably forecasts recessions.
But here’s why they’ll be wrong this time. Inverted yield curves forecast recessions because they correctly predict monetary tightening will cause a credit crunch. This in turn sparks a financial crisis that tanks both the economy and stocks.
The thing is, we’ve already had the financial crisis. It was the regional bank sector mini-meltdown in the first half of 2023. And we’ve skated by because the U.S. Federal Reserve handled it. The Fed flooded U.S. banks with liquidity via the Bank Term Funding Program. Now, we’ve moved on – except those who hold on to the economic “hard-landing” scenario.
In the meantime, market interest rates have come down, taking pressure off the credit system. Declining rates are also a form of economic stimulus. The Fed will soon start cutting rates at the short end, continuing this trend.
Outside of a credit crunch, the real canary in the coal mine to watch is business activity, notes Mark Zandi, the chief economist at Moody’s Analytics. “Businesses are the first to signal trouble as they rein in payrolls and investment,” he says. That undermines consumer sentiment, and a vicious cycle of weakening demand and risking layoffs ensues.
“Right now, there is no sign of that,” Zandi adds. “Businesses remain stalwart in their refusal to lay off workers and rein in investment. The economy continues to perform well, and prospects are improving as inflation recedes without an increase in unemployment.”
Moreover, the U.S. in the midst of a productivity boom that will continue due to elevated business investment in new technology and equipment. Higher worker productivity boosts profits and takes the pressure off companies to raise prices (link).
Plus, remember that economies usually benefit from election-year spending by the political party in power.
2. Consumer spending dries up as savings decline: Consumers drive the economy, so if they really do close their wallets because they’ve burned through their Covid pandemic savings, that won’t be good.
But this won’t happen. First, workers cocooned by the “lay low” mentality of the pandemic are circulating again. “The post-pandemic surge in labor force participation has led to a surge in total hours, and supported growth in disposable income,” says Bank of America economist Michael Gapen.
Next, U.S. employment remains high, and jobless claims are low, notes William Blair economist Richard de Chazal. Claims hit their lowest level in over a year, for the week ending January 13. The bottom line here is that consumers tend to keep spending until they lose their jobs.
Other factors also support consumer spending, says Ed Yardeni of Yardeni Research. He points to boomers retiring and spending their cumulative $75 trillion in net worth or passing it along to their heirs. Close to 40% of U.S. homeowners are mortgage-free, and most of the rest were able to lock in record-low mortgage rates.
A “misery index” tracked by Yardeni (the unemployment rate plus inflation) fell to 7.1% during December, well-below its historical average of 9%, Yardeni says. This is one reason the University of Michigan consumer sentiment index jumped in January to 78.8 from 69.4 in December.
3. Inflation makes a comeback: Like generals, stock-market bears often make the mistake of fighting the last war. So, when we learned earlier this month that December inflation firmed up, it supported the bear case that inflation may not be so transitory after all.
But inflation will continue to fall. For one thing, history shows it tends to fall as fast as it went up, after it spikes. Also, there’s a lot of natural downward pressure on price increases. China and Europe are suffering weak economies. Less demand from those regions puts downward pressure on oil prices and the price of goods. “China continues to export deflation to the U.S. and the rest of the world,” Yardeni says.
Rental vacancy rates are on the rise and this puts downward pressure on rent — the sole holdout inflation component, Zandi says.
The hidden gift for stock investors in all this is that that declining inflation pushes down cash yields. This has historically sent more money to stocks from cash, notes Bank of America strategist Savita Subramanian. The tipping point: 5% yields on cash. Below that, people put more cash into stocks. Money market funds have a record $6 trillion in cash. “Both institutional and individual investors are sitting on high cash levels,” she says.
4. Sentiment is too bullish, making the market vulnerable: When bullish investor sentiment gets too high, it makes the market vulnerable to pullbacks, in the contrarian sense. I just don’t see it. Consider these data from the quant analysts at Bank of America.
Cash at stock mutual funds is one standard deviation above average. That is not elevated sentiment. Hedge fund exposure to discretionary stocks — a bullish bet — is near historical lows. Investment fund exposure to defensive consumer staples remains eight percentage points higher than at the beginning of 2022. Exposure to consumer discretionary is four percentage points lower. Private equity funds have record dry powder (cash). Households have $18 trillion in cash, up from $13 trillion before the pandemic.
Sell-side strategists are equally cautious. Bank of America tracks a sell-side indicator based on strategists’ recommended portfolio allocation to stocks. This indicator is stuck in neutral, in line with the 15-year average. Typically, after readings at this level, the S&P 500
SPX
rises 13.5% in the next 12 months. “Peak recession fears are likely behind us, but positioning still reflects more fear than greed,” concludes B of A.
5. Oil prices spike due to the Middle East war: High oil prices pinch consumers by spiking gasoline prices, and they hit corporate profits. I’m not smart enough to know if the conflict in the Middle East will shut down oil shipping lanes, leading to an oil price spike. But if it does, the disruption will have to last for a long time to create a recession. Oil prices remained above $100 for six months after Russia invaded Ukraine in February 2022, and no recession ensued.
Meanwhile, forces including the weak economy in China and record U.S. production continue to limit upward price pressure on oil. Some analysts even question how long OPEC+ will stay unified on production limits — given that Angola just left the oil cartel.
The bottom line: Markets can correct at any time. But if I’m right that the diehard bears have it wrong, it makes sense to stay in stocks and be overweight cyclical names in consumer discretionary, energy, materials and industry, and discounted small-cap names that stand to do well as market breadth broadens.
Michael Brush is a columnist for MarketWatch. He publishes a stock newsletter called Brush Up on Stocks. Follow him on X @mbrushstocks
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