Why the stock market could plunge 46% in the worst-case scenario: analyst

  • Gordon Johnson says the bond market and the stock market are calling the Fed’s bluff.
  • He added that inflation is too high for the Fed’s current benchmark rate of around 2.5%.
  • He suggested that investors reacclimate themselves to shorting stocks.

On the days this year when the Federal Reserve raised interest rates, the stock market rallied significantly. And then the day after each raise, it sold significantly. That’s the pattern Gordon Johnson, CEO and founder of GLJ Research and an analyst of about 18, has seen since the fight against inflation began in mid-March.

For example, after the Fed announced its second hike of this cycle on May 4, the Nasdaq 100 rose 3.4%, he said. The next day, the index fell 5%. On June 15, a similar pattern unfolded: the index was up 2.49%, only to fall 4% the following day.

It looks like the market is sending mixed signals about the effectiveness of the Fed’s rate hikes. Johnson felt the same way about Jerome Powell’s speech on Wednesday: While the Fed Chairman was hawkish on fighting inflation, Johnson thinks the current rate hikes aren’t enough.

His firm offers in-depth coverage of companies in sectors such as steel, iron ore, electric vehicles, solar energy, lithium-ion production and cannabis. He told Insider he’s pegged about 85% of the stock to a “sell” rating. Its outlook is bearish to say the least for the rest of the year.

The June consumer price index, which measures the change in the prices of goods and services, rose 9.1% from a year ago. The current Fed benchmark funds rate of around 2.5% is still far too accommodative, he said. He thinks the central bank needs to get extremely aggressive or inflation will stay high.

“Taylor’s rule suggests that the fed funds rate must be at CPI inflation for inflation to start falling. , is always a joke and it’s said the market,” Johnson said.

Clearly Powell is focused on bringing inflation down to 2%, he noted. But this can only be achieved through a decline in economic activity. Yet nominal spending continues to grow at an accelerating rate, fueled by high wealth, strong wage growth and strong credit growth, he added. All of these factors are expected to slow significantly before inflation can be brought under control.

So far, these variables have not yet shown signs of slowing down. He pointed to year-over-year credit growth, which tends to reach all-time highs. Wage growth also remains strong at 6.7%, also at historic highs, he noted. Finally, household net worth hit a record $150 trillion earlier this year, and it’s still at near all-time highs, he added.

If that’s not enough, the bond market is also sending a mixed signal. When interest rates are raised, bond yields should rise, but that’s not happening, Johnson said. Yields on 3, 10 and 30 year bonds are down. Indeed, the bond market, as well as the overall stock market, which continues to recover, expects a rate cut in early 2023, which means it is essentially calling the Fed bluff, he said. he noted.

Investor beware

Johnson believes there will be a significant reduction in overall economic activity, including lending, debt availability, wages, and asset prices in stocks and real estate.

On Wednesday, Jerome Powell said he doesn’t think we’re in a recession because of parts of the economy that are doing too well, especially the labor market.

While things like household wealth remain strong, it’s critical to note that this indicator includes assets, most of which are owned by the wealthy, call it the top 5%, Johnson said. People who actually spend money to grow the economy are in a different position. For example, consumer confidence is at near record lows in July and the savings rate is at low levels, he noted. In short, inflation creates demand destruction.

“So when everyone says the consumer is strong, that’s a hugely misleading and political statement,” Johnson said.

The workforce is about to take a hit, he said. As evidence, he pointed to the evolution of office space as a foreshadowing. Amazon halted construction of five office towers and canceled plans for a sixth in Bellevue, Washington. Salesforce has rented out half of its offices in San Francisco. Facebook has also halted plans to expand its offices in New York.

While headlines cite hybrid working as the main reason, Johnson says it’s because the tech sector is about to suffer a massive wave of layoffs, and it’s going to spill over to other sectors. .

“There has been a backlog of offices and employees by a number of technology companies that will never be able to expand into this space and will never have enough business for those employees,” Johnson said. “I think it’s reversing and you’re seeing a number of job cuts.”

Some tech companies are already missing out on revenue. Meta, Facebook’s parent company, fell short of its second-quarter revenue and earnings-per-share expectations. Alphabet, Google’s parent company, also failed after it missed expectations for its earnings per share. And it will only get worse, he noted.

While Johnson stressed that no one can really predict the bottom, he called 3,200 for the S&P 500 a key support level based on technical analysis. But beware, investors: March 2020 lows when the index hit 2,200 — 47% below its Friday close — are also a worst-case scenario possibility, he added.

He noted that the S&P 500 is currently trading at a price/earnings multiple of around 18 times. Yet there is a significant slowdown in earnings, growth, and credit availability.

“I think the initial decline in stocks was because people were saying ‘okay, earnings are going to be lower’, but you haven’t had that multiple squeeze yet. So I think there’s a second lower leg coming in,” Johnson said.

Perhaps the real signal of doom comes from businesses that historically tend to do well during a recession due to shifting consumer behavior towards affordability.

For example, Johnson pointed out that Walmart had lowered its earnings expectations because consumers feared discretionary spending and that McDonald’s couldn’t beat its numbers. The burger giant’s revenue was $5.72 billion, below the expected $5.82 billion, already down 1.11% from the year-ago quarter .

As for the small percentage of stocks he has a “buy” rating on, one is Trinity Industries Inc. (TRN), a company that owns businesses that supply products and services. services to the industry, energy, transport and construction sectors.

Johnson believes the rail sector in particular is important because freight transport is essential. Additionally, chip shortages have caused a slowdown in production in the auto manufacturing industry. This will make railways even more attractive, he added.

He also likes First Solar (FSLR), a solar panel maker, because he thinks the US government will step forward to support US solar producers.

Finally, he thinks investors should get back to shorting stocks.

“There are times to buy stocks and there are times to sell them. There’s nothing wrong with shorting stocks, despite the bad reputation of short sellers,” Johnson said.

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