Earnings expectations are 'too rosy,' but recession is unlikely

Ned Davis Research chief US strategist Ed Clissold joins Market Domination Overtime to give insight into recent economic data, share takeaways from the first half of the year, and make predictions about the market moving forward.

Clissold notes that a recession is not a scenario that he foresees: "Now I mentioned earlier earnings expectations second half probably a little bit too rosy. Consensus estimates about 20% for Q3 and Q4 versus the previous year. It's probably more like high single digits to low double digits. So there'll be some downward revisions," he notes.

He adds that the "bigger risk" is that after a strong first half of the year, "a lot of people are in the market. So a little bit of bad news could cause a pullback, but we'd be looking for a pullback to maybe a small correction. Not necessarily a bear market. "

For more expert insight and the latest market action, click here to watch this full episode of Market Domination Overtime.

This post was written by Nicholas Jacobino

Video transcript

As the first half comes to a close, the S and P 500 is not a tear.

It's up about 15% on the year already driven by largely by big tech and A I.

Our next guest thinks this bull market still has room to run for more.

We're bringing in Ed Clissold, chief us strategist at Ned Davis Research Ed.

It's good to see you.

So it sounds like what you're saying, Ed here is, listen, if the economy is decent and earnings are decent, let's not overthink it that the good times can continue.

Yeah, that's a great summary.

Let, let's not get too caught up in the minutia.

Uh, earnings growth is going to be pretty solid this year.

We're getting quarter on quarter acceleration and growth.

It's probably gonna be some downside revisions.

Just a second half.

Estimates are a little bit rosy but overall good earnings growth.

And while the economy slowing the chances of a recession over the near term are pretty low and that's a recipe for the fed to likely be able to cut probably once in the second half of the year.

And so a slow easing cycle decent earnings growth.

Um and uh mo moderate and falling inflation, that's a pretty good backdrop, you know.

Um, you might have seen, uh JP Morgan's Marco Kano came out with a note today and said he thinks the S and P 500 is gonna fall to 4200 by year's end.

Among other things, he thinks that the market is pricing in too optimistic, an outlook for a broadening of earnings growth uh beyond tech mega cap.

What do you think of that scenario?

Well, I I think a 4200 price target implies a recession is coming.

You normally don't get that kind of a decline unless you're going into a recession.

So, uh it's not just a hey, earnings growth may not be as good as we think that that's really saying that there's some, some really bad news coming down the pike because that's not really what, what we think is probably going to happen.

Um Now I mentioned earlier, you know, earnings expectations, second half, probably a little bit too rosy.

Consensus estimates about 20% for Q three and Q four versus the previous year.

It's probably more like high, um you know, high single digits to low double digits.

So there be some down downward revisions.

But I think if you want to talk about risks, probably the bigger risk is that after such a good first half of the year, a lot of people are are in the market.

So a little bit of bad news could cause a pullback, but we'd be looking for a pullback to maybe a AAA small uh correction, not necessarily a bear market.

And another, another, you know, we're talking about variables for, for investors to consider.

Another one I want your, your take on is just valuation.

When you, when you look at where we're at right now at the market ed, how does valuation look to you?

Does you know, attractive extended?

How would you characterize it?

Yeah, stocks are, are a little bit stretched.

If you were to look at the trailing pe for the S and P 500 it's, you know, above um its long term average not hugely.

So, you know, like to say, if it's more than two standard deviations, um that's like the top 5% uh of observations, that's when it becomes like a real front burner issue.

Usually it's when earnings growth rolls over, that's when these kind of moderately elevated valuations become a bigger issue.

I think where, where I'm more focused for the second half of the year is relative valuations that is stocks versus bonds.

We've entered a regime where if bond yel uh spike, then we saw that, for example, last year tenure got up to 5% and we got a 10% decline in the S and P 500 pretty quickly.

I think that's the bigger risk, not our base case.

But if, let's say inflation does remain sticky and you get inflation expectations, get out of hand and interest rates start to rise again.

That's when investors may say, hey, I'm getting a better deal in the bond market.

So let's focus there.

So that's I think where the valuation risks are.

Um What do you think is gonna propel stocks higher in the second half of the year?

Is it gonna continue to be tech mega caps?

Is it gonna be other areas that are gonna start to play?

More catch up?

Yeah.

So as of right now, we're overweight, uh tech, we're overweight growth.

So that's kind of more, more of the same and, and more broadly, if you're getting a, a modest slowdown in economic growth, the stocks that tend to do well are growth stocks because they don't need the economy to do very well to grow their earnings.

They're not like an industrial company or materials or energy that really levered to the economy.

Uh So that's where we are at the moment.

Now, I think if, if we do get into a little bit of a, of a pullback or even closer correction territory and then you want to get defensive, that's where, you know, utilities, staples, um uh uh health care and telecom, those tend to do best again, that's not where we are at the moment.

But if people are thinking along those terms, maybe now is the time to do a bit of research to see you know which sectors, which stocks you want to focus on.

You know, I can't let you get out of here talking about politics, had that big debate last night.

Um, and I'm just curious, how are you thinking about this election?

Just as a, as a market strategist.

How are you thinking through it?

Yeah.

So the way I think about it is election year rallies often start when it becomes clear who the winner is going to be like in 1996.

Very clear, Clinton was going to get re-elected.

He had two very small Pullbacks first half of the year and the market ripped higher the second half 04 different situation.

Bush, uh, Kry, very close.

It wasn't until election night that it became clear Bush was going to win and then after that, uh, the market retired the last couple of months of the year.

So we were thinking this is gonna be a very close election probably, you know, still is.

But, you know, if momentum starts to move towards Trump's direction because of Biden's performance, maybe that election year, uh, rally starts a little bit earlier, we had a good start to the year, second best, first half of election year since 1928.

So we've already priced in some good news but maybe some of that general election uncertainty, uh, dissipates, uh, if it becomes clear who the winner is going to be, we shall see, I'm not holding my breath.

Thanks a lot.

Appreciate it.