Prepare for the Storm - BCA Research's Stock Outlook

Consumer Momentum Slowdown

After the surge in "revenge spending" following the COVID-19 pandemic, consumer momentum has shown a distinct slowdown. Home Depot and Lowe's, for instance, have witnessed a slump in revenues despite the increase in home equity. This indicates that the previously expected pickup in home improvement spending may not materialize as expected. Walmart and Target's earnings calls have also signaled a rise in bargain hunting as consumers tighten their budgets. It seems that the post-pandemic spending spree is coming to an end, and this could have a significant impact on the stock market.

Compared to the end of 2019, US consumers have seen a notable increase in home equity and household wealth due to the stock market's stellar rally. However, this has not translated into sustained spending growth. The data clearly shows a weakening in consumer sentiment and spending patterns, which is a cause for concern for stock market investors.

Softening Labor Market

The October employment data presents a mixed picture. While the job openings rate climbed from a four-year low in September back above the 4.5% threshold, the quits rate rose and the hires rate slipped to revisit a four-year low set in June. This "one-step-forward-two-steps-back" trend suggests that the labor market is softening, which could lead to a recession if it continues.

BCA analysts believe that this softening in the labor market will eventually provoke a wave of layoffs. A shrinking payroll could lead to slower spending, which in turn could trigger further payroll contraction and slower spending growth. This vicious circle could have a domino effect on the stock market, as companies with weaker financials may see their stock prices decline.

Historically High Stock Valuations

The S&P 500 is currently trading at 23 times above annual earnings, which is nearly two standard deviations above its mean. Analysts project earnings-per-share growth of 13% in 2025, which is nearly double the 6.6% postwar average. Such extreme valuations make risk assets vulnerable to even slight disruptions.

With financial markets currently discounting the probability of a recession, stocks appear to be a risky investment. Even in the absence of a recession, risk assets could disappoint as the current prices do not bode well for future returns. These high valuations pose a significant outsize risk to the stock market's two-year bull rally.

As a result of these three growing trends, BCA Research recommends rotating out of stocks before buying the dip in the event of a sharp decline. They expect an equity bear market to unfold sometime in the first half of 2025 and are looking for an opportune entry point to position against equities if their stop is triggered. They will be eager to narrow the underweight soon after the 20% bear-market threshold is reached and may look to overweight equities around -30% to -35% if the market falls that much.