Estrategia y temas
February 13, 2023
Bond investors deliver a message of recession
Leading economic indicators point to a hard landing
With corporate earnings and valuations set to fall...
... stock markets will struggle to extend their January rally

CHART OF THE WEEK: "Growth in output and corporate profits"


2023 kicks off with a bang. Does the future look bright for investors? Stock markets have performed very well in the first six trading weeks. The flagship US equity index, the S&P 500, has risen by +9%, its technology sibling, the Nasdaq, by +17%, while its European counterpart, the Euro Stoxx, has risen by +12%. Naturally, investors are wondering whether this is another bull run or a fourth bull trap. Looking at the signals sent by the bond market, the answer to this key question does not seem so hard (see Fig. 2).

In the United States, two-thirds of the companies that make up the S&P 500 have released their earnings for the fourth quarter of 2022. 70% of them have beaten estimates (see Fig. 3). This may sound positive, but it is the weakest result since the Great Financial Crisis in 2008. Their profits fell by -5.3% compared to last year. They were affected not only by the poor results of communication companies and financials, but also of the major technology names such as Meta, Alphabet, Amazon, and Apple. Fortunately, not all of them were penalised. Meta, for example, which managed to beat earnings expectations and cut costs, jumped to its highest level in six months. At the other end of the spectrum, defensives like utilities and healthcare firms are doing well.

Globally, the next few quarters will not be any better. As earnings fluctuate with the economic cycle (see Chart of the Week), they will be negatively impacted by weak demand. Furthermore, companies have been hiring as their production has begun to weaken. In doing so, they have degraded their productivity (see Fig. 4), which will weigh more heavily than usual on future earnings.

In light of recent leading indicators, including weak new order books in industry (see Fig. 5), listed companies' profits will contract further. Our econometric modelling estimates a low of -20% over the full year 2023 (see Chart of the Week), a far cry from the consensus. Analysts expect a modest earnings squeeze, with a decline in the first half and a rebound thereafter. Their estimates are based on a soft landing for the economy, which almost never happens. In the vast majority of cases, economies make hard landings. In the last 23 years, a decline in earnings has been expected only four times (2001, 2008, 2015, 2020). In each case, equity indices have experienced a bear market.

As stock markets have risen at the same time as earnings have fallen, valuations have risen. In other words, listed companies have become as "expensive" as they were at the beginning of last year before the stock market correction. Some may find them "cheap", but the ratios are well above their previous cycle lows: 1995, 2002, 2008, 2011 or 2020 (see Fig. 6). Therefore, over the next 10 months, there is a real risk of a further valuation squeeze. If bond investors are correct, a 14x earnings multiple would not be unrealistic (see Fig. 7).

2023 is the best start to a year for multi-asset portfolios since 1987. Equity markets were not the only positive contributors to performance. Bonds and gold gained 3% to 6% over the period. This is slightly less spectacular but just as notable, and, more importantly, the likelihood of an upcoming downturn in these assets is much lower.


Past performance is no guarantee of future results. After six particularly rewarding weeks in 2023, this disclaimer has never been more appropriate for the stock markets' current situation. The leading indicators, and the implied economic scenario, leave little room for doubt: the recession will be severe in 2023. Corporate earnings will suffer, dragging stock market indices to new lows. It is too early to add risks.