• Piper Sandler's Michael Kantrowitz says a recession is hurtling toward the US economy.
  • He said tightening lending standards and high food and energy inflation are giveaways.
  • Kantrowitz has a 3,225 2023 price target for the S&P 500.

Michael Kantrowitz doesn't agree with the trope that the stock market is a forward-looking, discounting mechanism.

Sure, investors take in information and try to price stocks at appropriate levels given how they think they'll perform in the future. 

But when it comes to things like an economic cycle and employment data, markets are seemingly always reactive, the Piper Sandler strategist told Insider this week.

He pointed to stocks falling in lockstep with rising unemployment claims in 2007, 2000, 1990, 1981, 1973, and 1969. Then there are the countless assurances from central bankers, economists, strategists, and market participants that the economy would avoid recessions that ended up coming to pass. 

Today, investors are again doing a poor job of forecasting rising unemployment claims in the months ahead, Kantrowitz believes. He's calling for a recession later this year, and for the S&P 500 to shed 22% of its value and fall to 3,225 by the end of 2023. 

He said weekly unemployment claims will rise to 300,000, up from the 229,000 seen the week of May 20. On a year-over-year basis, the percentage change in unemployed persons is slowly shrinking and will soon go positive, he believes.

earnings
Piper Sandler

He also said 12-month forward earnings estimates for the S&P 500 would drop by 15% from $245 to $215 by the end of 2023, which informs his 3,225 call. Earnings estimates are already starting to dip negative as the economy slows. Historically, that has meant a recession has already begun, or is about to start.

forward earnings S&P 500
Piper Sandler

"I feel like a weather man who's coming out at the end of May and saying, 'In December it's going to be cold.' And people walking outside their house right now and it's 80 degrees and they're like, 'What are you nuts?'" Kantrowitz said. 

Some in the market are still betting on a soft landing scenario, where the economy avoids a recession despite the Fed's hiking cycle to bring down inflation.

But Kantrowitz's analysis shows another outcome. To help form his outlook, he looked at the 12 Fed tightening cycles since the 1960s. Eight of them ended in recessions, and four of them ended in soft landings (1966, 1989, 1995, and 2019). 

In all of the recessionary outcomes, he found two variables consistently present: banks were tightening lending standards, and there was a spike in food and energy inflation above 5%. Both have been present in the current cycle. 

Food costs in April were up 7.7% year-over-year. Energy costs were falling in April, but were up as much as 41% in 2022. 

A growing number of banks are also reporting that they're tightening lending standards as they try to keep liquidity levels up following the closures of three US banks this year. Here's the results of the Fed's Senior Loan Officer Survey, which shows 46% of banks now tightening standards.

credit standards
Federal Reserve Bank of St. Louis

The bigger picture

Kantrowitz's 3,225 call is the lowest 2023 S&P 500 price target among major Wall Street strategists.

Other targets on the low end include BNP Paribas' Greg Boutle at 3,400; Cantor Fitzgerald's Eric Johnston at 3,500; and Barclays' Venu Krishna at 3,725. Morgan Stanley's Mike Wilson has a year-end target of 3,900, but still sees a drop to somewhere between 3,000-3,300 in the meantime. Wilson was the most accurate forecaster among major strategists in 2022. 

Underpinning Wilson's call is an earnings recession this year that investors aren't pricing in.

"A very healthy reacceleration is baked into 2H consensus earnings estimates (mid-to-high single-digit growth for both the overall index and the index ex-tech). This flies directly in the face of our forecasts, which continue to point materially lower," Wilson said in a note in May.

"We remain highly confident in our model given how accurate it has been over time and recently," he continued. "We first started talking about the coming earnings recession a year ago and received very strong pushback, just like today. However, our model proved quite prescient based on the results and is now projecting a much more dire outcome than consensus. Given its historical and more recent track record, we think consensus estimates are off by as much as 20% for this year."

Various signals point to further economic weakness ahead. These include the inverted Treasury yield curve, The Conference Board's Leading Economic Index, and faltering consumer sentiment numbers. On Tuesday, The Conference Board said it's Consumer Confidence Index fell to the lowest level since November 2022.

Here's the firm's Leading Economic Index — a combination of indicators for manufacturing activity, stock performance, housing activity, consumer confidence, and more — which is now near levels seen in the 2001, 2008, and 2020 recessions.

LEI
The Conference Board

The National Federal of Independent Business survey on hiring intentions also shows a slowing labor market ahead. 

hiring intentions
NFIB

So far this year, monthly job gains have been stronger than economists' forecasts, giving hope to bulls that the economy can withstand high interest rates. That strength showed again on Friday as the Bureau of Labor Statistics said the US economy added 339,000 jobs in May, well above the expected 190,000.

But as Societe Generale's top global strategist Albert Edwards points out, watch for downward revisions to previous months that could paint a much uglier picture of the economy than previously thought. February and March numbers were already marked down by more than 70,000 jobs each in April's report last month, though March and April were revised upward in Friday's report by 52,000 and 41,000, respectively.

Further, unemployment ticked up to 3.7% from 3.4% in May. If that trend continues, and the labor market weakens in the months ahead, stocks could be on their way to Kantrowitz's projected 3,225 level. If it doesn't, bulls could get the soft-landing scenario they're betting on.