Investors, already grappling with a declining stock market and fearing the U.S. economy is heading into a recession, are now turning their attention to the consumer. On the one hand, consumer discretionary stocks are among the hardest hit.

Market fixation on peak inflation and how many times the Federal Reserve might raise interest rates is giving way to recession fears, according to Paul Christopher, head of global market strategy at the Wells Fargo Investment Institute. .

The change was seen over the past week as stocks tumbled amid investor concerns over consumer spending trends, Christopher said in a phone interview.

“The market is finally starting to realistically price a recession,” he said.

So far, consumer sentiment has proven to be as elusive as market entries and exits.

The crisis has been “very difficult to bear,” said JJ Kinahan, chief market strategist for online brokerage firm Tastytrade Inc., in a telephone interview. “It’s like coming in and boxing day after day, getting your ass kicked, but you haven’t been knocked out yet. So you have to go back and box again.

Stocks have yet to experience a “big bottom” and, with the market vulnerable to a bearish rally, sell any “rips,” advised investment strategists at BofA Global Research, in a May 19 note.

On Friday, the S&P 500 SPX index,
+0.01%
traded in bearish territory but avoided closing there as it made a gain in a mixed close for US stocks. Still, the S&P 500 and other major benchmarks suffered another week of losses, with the Dow Jones Industrial Average DJIA,
+0.03%
booking an eighth straight weekly drop for its longest losing streak since April 1932.

In a May 18 note, the Wells Fargo Investment Institute said it was adjusting its stock forecast and price targets for a “likely” recession, moving the utilities sector from “neutral” to “most unfavorable”. Utilities are considered defensive, unlike the consumer discretionary sector, which Wells Fargo downgraded from “unfavorable” to “neutral,” according to the rating.

Consumer Discretionary SP500.25,
-1.53%
was the worst-performing sector in the S&P 500 on Friday, closing lower and booking a seventh straight week of declines for its longest losing streak since July 1996, according to Dow Jones Market Data.

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Here are Wells Fargo’s equity sector preferences, as reported in its May 18 report.

WELLS FARGO INVESTMENT INSTITUTE


“sticky” inflation

“Inflation hits purchasing power,” Christopher said. “It’s so sticky,” he said, “that it’s going to be with us for a while, even after the Fed raises rates.”

Lack of profit in profit results reported by Walmart Inc. WMT,
+0.11%
and Target Corp. TGT,
+1.26%
last week sparked investor concern that high inflation is dampening consumer spending, while eroding corporate profit margins. Shares of Walmart plunged more than 19% last week and Target fell about 29%.

Lily: Walmart says consumers are opting for private label for products like dairy and bacon

“Unfortunately, gas prices rebounded to a new high in May and with runaway inflation in most categories, people are spending more money on fewer items,” said Beth Ann Bovino, chief U.S. economist for S&P Global Ratings, in emailed comments in May. 17.

When S&P adjusted U.S. retail sales in April for inflation, “a scary split has emerged over the past year that has only widened in April,” Bovino said.

S&P GLOBAL


“Purchasing power has been squeezed, especially for low-income households,” she said. “While the savings accumulated during the pandemic gave households a cushion to absorb these higher prices, these buffers eventually run out.”

Although the labor market remains strong, new jobless claims in the United States in the week ending May 14 hit a four-month high. Christopher said the Wells Fargo Investment Institute thinks a “mild recession” could begin later this year.

They are not alone.

“We continue to expect that the tightening of financial conditions triggered by Fed policy will likely lead to a recession by the end of 2023,” wrote Deutsche Bank analysts led by the chief economist. American Matthew Luzzetti, in a research note dated May 20. weeks, financial conditions in the United States have tightened sharply.

WELLS FARGO INVESTMENT INSTITUTE


This week, investors will get fresh economic data on inflation, consumer spending and disposable income. The U.S. economic calendar also includes readings on consumer sentiment, U.S. manufacturing and services, initial jobless claims, and minutes from the Federal Open Market Committee’s latest policy meeting.

Nervous investors

While investors are jittery, stock market lows tend to form after “panic selling,” and the recent drop so far has been “orderly,” according to Tastytrade’s Kinahan.

The S&P 500 is down about 18% this year through Friday, while the Dow Jones is down 14% and the tech-heavy Nasdaq Composite is down about 27%, according to FactSet.

Lily: The S&P 500 narrowly avoids a bear market. How long do they last once they arrive?

From the perspective of bull investors, bear markets involve “wild, scary, and dystopian price action,” BofA investment strategists wrote in their note. “The tape is already showing heavy damage”, with an “inflationary shock” largely integrated into the “rate shock”.

Once the “recession shock” is out of the way, “lows will be set,” the strategists wrote, citing a bullish outlook.

Both Kinahan and Wells Fargo’s Christopher cautioned against attempting to time the market, with Kinahan describing any attempt to bottom out as a “fool’s run.”

Christopher said investors might consider putting small amounts of money to work over time as the market falls to new lows and buying quality stocks to minimize losses. “If you’re a long-term investor, you don’t want to take money out of the market,” he said.

With rising recession risks, Wells Fargo Investment Institute cut its year-end target price range for the S&P 500 to 4,200-4,400 from 4,500 to 4,700, according to its report. That’s above the index’s close on Friday at 3,901.