Still Soft: Conclusion

Genevieve Signoret

(Hay una versión en español de este artículo aquí.)

Today we share our final excerpt from the latest edition of Quarterly Outlook. Click here to read the full report.

Conclusion

We can’t know whether the stock market has bottomed, because it depends on events that are unpredictable. What we can do is build different scenarios for the future and build investment strategies that can perform acceptably well under any of them.

Today, the unpredictable events driving outcomes are negative supply shocks and their aftershocks. These shocks have driven inflation rates up so high that central bankers are now single-mindedly fixated on holding on to their credibility as to their capacity to bring inflation rates back down to target. So they’ll keep on tightening financial conditions until inflation rates are moving down sustainably and will keep conditions tight until inflation rates have returned to central bank targets.

Asset valuations as a result are suffering. And they will continue to do so until market participants start to expect central banks to soon go on pause.

If we are correct in our perception that supply shocks and aftershocks are starting to ease up, and if this trend continues, then U.S. inflation rates will soon peak and next year fall dramatically, allowing the Fed to take rates to only 3.75% before going on pause and thus avoiding a hard landing. Stock market valuations in this scenario already have already bottomed, though the road ahead to a sustained take-off will prove long and bumpy.

If a letup from negative supply shocks is instead delayed, the U.S. economy will go into a severe recession, and the bear equity market still has farther down to go.

In the highly unlikely case that the letup in supply shocks comes much sooner than expected, then not only the United States but also Europe and Mexico will experience soft landings, and in the wink of an eye we’ll be back in a bull market.

The key market risks to monitor, then, revolve around supply shocks: Europe’s capacity to cope with their energy crisis, China’s adherence to its zero-Covid policy, worker willingness to return to the labor force, the Russia–Ukraine war, and negotiations between Iran and the West.