Some Wall Streeters are factoring in a chance of a recession or at least a severe slowdown. - TIMOTHY A. CLARY/AFP/GETTY IMAGES
Economist Burton Malkiel might have called the stock market “a random walk,” but investors could at least use earnings guidance by companies as road signs. Now they are largely walking blind.
Last week, BMW reiterated its 2025 financial guidance from mid-March, but included the assumption that the Trump administration would roll back some of the more-recent tariff increases starting in July.
Though it will take a while, free trade across the U.S., Mexico and Canada “will be restituted once again,” BMW Chairman Oliver Zipse told analysts last Wednesday. “The disadvantages are far too big for everybody.”
Given that the U.S. and China agreed Monday to suspend most tariffs, following the announcement of a deal with the U.K. last week, there may be some ground for Zipse’s optimism. But equity analysts at Deutsche Bank weren’t as certain following the earnings report. “Obviously not everyone shares BMW’s optimism,” they wrote to clients.
While unorthodox, the German carmaker’s predictions are one way to cope with the fact that nobody knows what the economy will look like in a few months’ time.
Ford, Jeep-owner Stellantis, Delta Air Lines, and UPS took another route, scrapping their 2025 guidance altogether. Others, such as General Motors, PepsiCo and Procter & Gamble, have lowered targets, while Volkswagen excluded tariffs from its outlook. United Airlines, creatively, offered one scenario for a stable environment and another for a recession.
The current median expectation by Wall Street is that the S&P 500’s earnings-per-share growth over the next 12 months will be 8.9%, which amounts to a forward price/earnings ratio of 20.6—historically elevated but in line with the average of the past five years.
Here is the problem: Analysts take their cues from the same corporate executives who are now issuing meaningless forecasts. In reality, the index could be much more expensive than it looks.
Goldman Sachs’s latest forecast, which dates from before the accords with Britain and China, estimated a 45% chance of a recession over the next 12 months. Yet, after almost entering a bear market on April 8, the S&P 500 is now only about 0.6% below where it was at the start of the year.
To be sure, a downturn is less likely than a month ago. President Trump has de-escalated his trade war, and official data for April showed no big deterioration in the job market, contradicting what “soft” survey indicators were suggesting.
Also, analysts aren’t fully oblivious to the risks ahead: Despite first-quarter earnings figures coming in strong and more companies than average upgrading their second-quarter guidance, brokers still revised down their estimates for the second quarter by 2.4% in April—much more than they usually do. And they are applying larger downgrades to forecasts starting a year from now or later, which has historically been a decent predictor of the economy cooling.
An argument can thus be made that investors are factoring in some chance of a recession or at least a severe slowdown, but also balancing that against a potential economic pop once U.S. consumers and businesses, which still have strong finances, make it through the next few months of chaos.
This doesn’t really make sense, though. Even if economic uncertainty itself ends up having no ill effect, it has now been confirmed that Trump’s trade deals will leave many of the recently announced tariffs in place, which means import-cost increases are coming. Companies will soon need to either accept lower margins or push up prices, which will affect sales.
Crucially, forward profit expectations for the S&P 500 and technology stocks in particular were already being downgraded before the trade war started. For reference, recessions typically involve a fall in earnings of 20% or more.
Assuming a very benign scenario in which earnings-per-share growth fell simply to the five-year average of 7.9% and the forward P/E ratio rose back to the maximum around which it has hovered in recent years, which is 22, the S&P 500 would still have only about 6% upside. That isn’t much when cash yields 4%.
Rather than focus on shaky forecasts, however, investors “may start gravitating toward looking at trailing earnings, because those are the ones that are real,” said Matt Stucky, chief equities portfolio manager at Northwestern Mutual.
They might already be doing that to a certain extent. Cheap “value” stocks, which have been very unloved over the past decade and a half relative to fast-growth Silicon Valley giants had been outperformers this year. That is, until Monday’s rally, which was led by tech stocks.
“There isn’t a whole lot of hope priced into value stocks, but valuation gives you a cushion whereas hope doesn’t,” said M&G Investments’s Fabiana Fedeli.
But this could ultimately make for a pretty bearish overall market, given that the promise of artificial intelligence remains the cornerstone of the U.S. investment case. If backward-looking P/E ratios are to be believed, valuations are extremely frothy, not far from those of the dot-com bubble.
Wall Street veteran Jim Paulsen proposes another rule: Since the end of World War II, S&P 500 returns have closely followed a logarithmic line upward. And, while the current upward deviation isn’t close to 1999 levels, returning to the trend over the next year would still imply a fall of roughly 20%.
Perhaps investors should just diversify as much as they can and have a bias toward “quality” companies with features such as balance sheets that can withstand extreme outcomes. Avoiding China-focused names such as Apple, this could argue for keeping the faith in market favorites such as Costco, Meta Platforms and Mastercard.
Still, none of today’s obscured investment paths might lead to particularly large gains.
