Markets may bottom out soon, but a sustained recovery is unlikely: Nomura

A ‘mechanical’ bottom is likely in stock markets in the next few weeks, but a sustained recovery is unlikely, said analysts at Nomura in a recent report. Stocks, Nomura said, have historically bottomed out during recessions but not before, and do not bottom out when policy rates are still rising. That said, it expects Asian markets to recover ahead of their US peers.

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“Assuming no major stimulus and/or reopening in China in the months ahead, we do not think conditions are in place to call for a sustained recovery in stocks. US Fed hikes will continue until March 2023 and a mild-but-long US recession lies ahead that may end in the fourth quarter of calendar year 2023 (Q4-23),” wrote Chetan Seth, Ankit Yadav and Anshuman Agarwal of Nomura in a recent report.

Click here for graphic: Market recovery vs economic cycle

Their analysis is based on a study of the last 12 recession cycles in the US, which suggests that US stocks have never bottomed ahead of a recession, but usually bottom during a recession and not before. The one exception, however, was the tech bubble burst in 2000, when stocks bottomed after.

“In terms of policy rates, in six of the past seven recessions (including the pandemic recession), US stocks have never bottomed while rates were still going higher. The exception was January-July 1980, but which eventually morphed into the double-dip recession of 1981 and saw another plunge in stocks,” Nomura said.

The specter of policy tightening by global central banks, especially the US Federal Reserve (US Fed) triggered large outflows across emerging markets by calendar year 2021 (CY21)-end. The Indian markets, too, saw foreign portfolio investors (FPIs) pull out nearly $33 billion between October 2021 and June 2022, data show.

“FPI flows towards India and other EMs from July 2022 started to turn largely positive with bouts of moderate selling. The above behavior could be again signaling that the aggressive rate hikes by the US Fed may be approaching its peak going ahead,” wrote Vinod Karki and Niraj Karnani of ICICI Securities in a recent note.

China holds key

Meanwhile, a sustained recovery in Asian markets, Nomura said, will largely depend on how the Covid situation and the ensuing curbs put in place to combat the pandemic in China plays out going ahead. 

“This was indeed the case in October 2008, when China launched a massive fiscal stimulus. Looking forward, the key is whether there is a sustained China reopening and/or massive stimulus, which leads to sustained recovery in China’s key economic data such as credit growth and property sector sales,” Nomura said.

Jobless claims

Based on the past 12 US recessions after 1948, the inflection points in jobless claims and/or non-farm-payrolls (NFP), Nomura said, tends to have the closest proximity to a sustained recovery in US stocks, with stocks generally seeing sustained recovery few weeks ahead.

“The implication of this view is that it is likely that we are not yet at the point of a sustained recovery in stocks. We note that historical episodes also suggest significant market volatility around key inflection points, as the market tends to be hypersensitive to economic data,” Seth, Yadav and Agarwal of Nomura said.

While there is significant uncertainty on timing of the bottom, Nomura believes that it is possible that some signposts may start to appear sometime by early first quarter of 2023 (Q1-23), and thus a sustained recovery in stock market may occur sometime in the first half of 2023. 

“The shape of recovery in stocks will also depend on the shape of the recovery in the economic cycle i.e. a ‘U’, ‘V’, ‘L’ or ‘W’,” Nomura said.