The fast inflation spike is leading to a slow recession shock that will push the stock market to new lows, BofA says

  • The stock market is poised to hit new lows this year as fast inflation leads to a slow recession shock, according to Bank of America.
  • The bank said cash and commodities should outperform stocks and bonds as inflation continues.
  • “Once [the] US tips from inflation to recession global EPS turns sharply negative [in] Q1 of 2023,” BofA said.

The ongoing inflation shock will lead to a slow recession shock that ultimately drives the stock market to new lows, Bank of America said in a Friday note.

The bank expects stocks to drop and yields to pop following Jerome Powell’s hawkish speech at Jackson Hole last week. 

“Jackson Hole marked the end of ‘Mission Accomplished’ summer trade of peak CPI, peak yields, [and expected] Fed cuts in 2023,” BofA’s Michael Hartnett said. But because inflation is unlikely to dip below 4% by 2024, the Fed funds rate is likely to exceed the 4% interest rate level, which mean more rate hikes ahead, according to the note.

And investors shouldn’t be surprised by a drop in the stock market even though the broader economy might still be holding up, as economic growth data is shaded by such high inflation readings, according to the note. 

“Nominal growth continues to be boosted by inflation, fiscal stimulus, past era of wealth accumulation, new era of ‘economic cancel culture’ (economic pain elicits immediate public sector bailout,” Hartnett said.

These factors create the dynamic of a “fast inflation shock, slow recession shock,” and ultimately, a recession is coming, according to the bank.

“Deflation in Asia, stagflation in Europe, and once US tips from inflation to recession global EPS turns sharply negative [in] Q1 2023,” Hartnett said. Such a downturn in corporate earnings would drive a sizable decline in stock prices.

Over the past 12 months, the S&P 500 generated $220 in earnings per share. “Applying a 20th century PE [multiple] of roughly 15x gets you to an S&P 500 index of 3,300 (our view),” Hartnett argued. But right now more people are applying a “21st century PE [multiple] of 20x.”

That would put the S&P 500 closer to 4,400. But trends that drove a premium PE multiple in recent years are fading, including accommodative Fed policies, geopolitical peace, and globalization. 

“New regime of higher inflation means secular view remains cash, commodities, volatility to out perform stocks and bonds; and inflation in things we don’t have enough of… energy, workers, places to rent, food, raw materials,” Hartnett said.

If the stock market follows a bearish trajectory to 3,300, then Hartnett recommends investors start nibbling on stocks around 3,600, representing potential downside of about 9% from current levels.

“We expect new highs in yields, [and] new lows in stocks,” Hartnett concluded.

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