John Rotonti interviews Wei Li, Global Chief Investment Strategist, BlackRock, as she explains what could be next for the markets.
John Rotonti: Why do you think a recession isn't fully priced into earnings or PE ratios? What data are you using to come up with this thesis?
Wei Li: As we think about equity price and equity valuation, in order to get to the price level of indices such as S&P 500, we have to make assumptions about interest rates, we have to make assumptions about earnings forecast. But then equally, as we look at the current market pricing, we can work backwards to understand what assumptions of interest rate and also what assumptions of earnings are baked in at the current price level. Well, S&P 500 and US equities have gone through a pretty volatile ride so far this year, but let's, for simplicity sake, look at S&P hovering around the level of 4,000 price point. Working backwards from this price level, it's assuming earnings growth of mid-single-digits for the entirety of 2023. That stands in contrast to our expectation of a mild recession for the US economy this year, which is what I meant by the recession outlook that we see is not fully reflected in the equity pricing at this juncture.
John Rotonti: How much further do you think earnings expectations need to fall?
Wei Li: Well, our forecast based on the various metrics that we monitor, including macro forecast including the translation from macro to earnings forecast. We are looking at minus 6% earnings growth for this year. There's a gap of almost 10% versus what's priced in, and our expectation. This minus 6%, I don't know how it sounds to you, but we're talking about a contraction and a recession, so it sounds like it's a very bearish forecast but actually, it's not too bearish. If you look at recent recessions like the global financial crisis or the pandemic, we have seen earnings from peak to trough of contraction up to 30%. But here we're just talking about earliest contractual versus last year of 6%. Yes, we see recession, we see contraction. There is a gentle one, is a mild one that we are expecting for the US markets.
