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The S&P 500 is still vulnerable to an earnings contraction (relative to expectations). Sell-side projections suggest 2023 S&P earnings will be 4% higher than last year. Some leading economic indicators imply that earnings may be lower this year than last year. But if so, disinflation and a further decline in 10yr yields could provide (at least partially) offsetting P/E multiple support. Crosscurrents may lead to a sideways “time correction” in the market, albeit with the potential for downside volatility along the way. The late 1940s analog remains relevant. 

Recession risk continues to be elevated and many classic warning signs remain on the checklist. But one interesting dynamic now that speaks to the chance of a soft landing is the fiscal policy picture/path. Fiscal stimulus is at a level inconsistent with past recessions (with the exception of the exogenous shock/lockdown of 2020). Also, the rate of change in fiscal stimulus went from a headwind to a tailwind in Q3 2022. The level and direction of fiscal policy should partially offset ongoing monetary policy tightening.

Additionally, budget deficits are an important driver of aggregate household savings (a frequent topic of discussion in the markets these days, with many analysts assuming household savings will continue to dwindle—I think that's inaccurate based on the fiscal path). Historically, fiscal stimulus increases through automatic stabilizers (e.g., an increase in the unemployment rate) or in response to a recession; neither is the case currently.

One hypothesis to consider: we may be in a rolling slowdown where categories of macroeconomic activity (income, spending, production, and employment) go through mild, temporary contractions but with an asynchronous cadence that lacks the self-reinforcing depth, diffusion, and duration of a true recession. The China reopening, early signs of an upturn in Europe, US fiscal stimulus, disinflation, and the tight labor market could all play a roll in that outcome. A Fed pause (which looks increasingly likely), combined with a soft(ish)-landing, would be a positive development for the market outlook.

Also, recession-bear markets typically have shorter lags between the start of the bear market and the start of the associated recession. There is still no strong evidence of the US economy being in a recession as of December 2022, a full year after the previous all-time high in the market. That’s pushing the limits of historical time lags. The longer the ongoing expansion lasts, the more likely it turns out to be a mid-cycle slowdown.

Right now, the economic outlook is particularly uncertain and data-dependent. Even if the US economy avoids an official recession in 2023, an earnings contraction is still on the table (earnings recessions are more common than economic recessions). Big picture, I still slightly lean towards the idea that we are in an ongoing secular bull market, which would suggest that any new market lows wouldn’t be too much lower than the 2022 lows. In short, the risk remains skewed to the downside in the near term but increasingly looks balanced to positive over the medium term.

Remarkably, unprofitable tech (as proxied by the IPO index) peaked almost a full two years ago (Feb 12th, 2021). The dotcom bust from 2000-2002 took just over two and a half years. Going by that reference point, there still may be a bit more to go both in terms of both price and time, but I would think we’re in the 7th or 8th inning there.

As always, the outlook remains data-dependent and everyone needs to put probability and reward-to-risk assessments in the context of their strategy, process, and time horizon. 

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