This article was written exclusively for Investing.com

As we begin to enter summer, there could be one more shoe for markets to drop as the risk of recession increases. After all, the US real in the first quarter was negative, and the likelihood that real GDP in the second quarter will be negative also increases. The Atlanta Fed GDP Now model projects 1.8% growth in the second quarter. But that number has been steadily falling, and with inflation at 8%, that’s not out of the realm of possibility.

These growing fears of a recession are also starting to weigh on the markets. Suddenly the went down, while the yields, including on the note, stopped rising. Not only that, but Fed Fund Futures now forecast fewer rate hikes and the possibility of a first rate cut by the summer of next year.

But at this point, at least the earnings estimates for the are still in place, and despite the sharp decline in the index’s PE ratio, the index did not anticipate a recession. Earnings estimates stand at $227.43 per share for 2022 and are higher than the roughly $220 they marked at the start of the year. Although these revenues have stabilized, they have not yet shown any signs of decreasing.

The yield curve has started to shift as rates fall. For example, the rate fell from around 2.8% to around 2.5%, while the 10-year rate fell to 2.8% from around 3.2% in the past 2 weeks. Additionally, the dollar index fell noticeably to around 101.80 from a high of just over 105. Potential signs indicate that the market is mulling over the heightened risk of a US recession and lowering expectations for future increases.

There have even been downward changes in Eurodollar futures, which predict fewer rate hikes, and the possibility of the Fed starting to cut rates by the middle of next year. . This is a massive change from rates that were soaring just a few weeks ago. On April 26, the Eurodollar futures contract for June 2023 was around 3.38%. Today, those same contracts are yielding around 3.15%, which is almost a full rate hike less. Additionally, Eurodollar futures saw the first rate cut between June and September 2023. Now these ratings have moved to potential between March and September 2023.

Eurodollar futures

All of these shifts in the currency and rates markets have undoubtedly been felt by equities, with the S&P 500 PE ratio falling sharply in 2022 due to rising rates. This caused the PE ratio to drop to around 17.2 when using forward 12-month earnings estimates, from 22.3 at the start of the year.

So while the index’s PE multiple has contracted, earnings estimates have not changed, leaving two big potential problems for stocks. If the US economy enters a recession, how low should earnings estimates fall, and if they fall, how much will the market’s PE ratio fall?

S&P Price to Earnings Ratio

For earnings estimates to hold, GDP can be negative in real terms but must avoid going negative in nominal terms, which is certainly possible given the current high rates. Since revenue and earnings are reported in nominal terms, the damage to earnings estimates may not be as severe and the declines may not be pronounced. In this case, the market might be able to sustain at current levels.

This makes for very difficult times to be an investor.

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