Next Week's Earnings Reports Could Be 'Final Round' Battle Between Hot Stock Market, Slumping Economy

The New York Fed recession probability model suggests there is a 57.7% chance of a U.S. recession in the next 12 months, the highest recession probability since 1982. However, you wouldn't know it by looking at the stock market. In fact, the SPDR S&P 500 ETF Trust SPY is actually up 8% year-to-date as the economy has cooled, and recession risk has risen.

Recession Red Flags: On Friday, LPL Financial chief global strategist Quincy Krosby addressed the strange divergence between the stock market and the economy and said next week could be a major turning point for investors.

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Krosby said there's a growing list of red flags for the U.S. economy. The Conference Board's Leading Economic Indicators (LEI) suggest a recession is imminent, the labor market is finally starting to soften, the Fed's latest Beige Book indicated "several districts" are experiencing stressed lending conditions, and crude oil prices are struggling to gain momentum despite OPEC production cuts. To make matters worse, the U.S. debt ceiling deadline is looming, creating even more economic uncertainty.

What's Going On? Krosby said the stock market's resiliency amid the growing list of bearish indicators reflects investors looking beyond current economic conditions and pricing in both Fed rate cuts and a resolution to the debt ceiling drama.

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In past quarters, Krosby said investors were willing to forgive companies with weak earnings as long as they included cost-cutting measures along with their guidance. However, the big sell-off in Tesla Inc TSLA on Thursday suggests investors may not be so forgiving of earnings misses from big tech stocks Microsoft Corp MSFT, Alphabet, Inc. GOOG GOOGL and Meta Platforms, Inc. META, all of which report next week.

"Price action has unequivocally won the ongoing tug-of-war, but where lower Treasury yields are reflecting recession fears," Krosby said.

"Next week could be the beginning of the final round of the push-pull skirmish between the market and economic trends."

Benzinga's Take: The stock market tends to be forward-thinking, but it may not be so anticipatory that investors can simply ignore and power through an entire U.S. recession without experiencing a considerable decline in the S&P 500. Much of 2023's stock market strength may be stemming from the fact that investors already priced in a severe U.S. recession when the Federal Reserve began aggressively raising interest rates in 2022.

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