U.S. stocks won’t bottom out until the middle of next year as the Federal Reserve pivots back to lowering interest rates, according to Arend Kapteyn, an economist at UBS Group AG UBS, +6.82%.
Kapteyn expects the S&P 500 SPX, +5.54% will fall as far as 3,200, which would represent a decline of nearly 16% based on the large-cap index’s value around 11:30 a.m. Eastern Time on Wednesday.
The decline is expected to be driven by weak corporate earnings growth and more Fed interest rate hikes, which will continue at least through the first quarter of next, the UBS economist said.
“We expect it will not regain its January 2022 high of 4,796 before end 2025,” Kapteyn said.
Ultimately Fed interest rate cuts will help to bail out stocks. UBS expects the Fed will cut rates by 175 basis point by the end of 2023 after the Fed funds rate peaks in the first quarter. They expect the yield on the 10-year note TMUBMUSD10Y, 3.819% will decline to 2.65%, driven by a sharp decline in real yields and softening breakevens. That’s compared with 4.110% on Wednesday.
It will be several years before the S&P 500 retakes its highs from January, UBS added.
Kapteyn’s forecast is based on expectations that forward price-to-earnings on the S&P 500 will bottom at around 14.5 times, which is roughly equivalent to valuation troughs from 2002, 2018 and 2020. By comparison, the forward price-to-earnings is 16.70 as of Wednesday, according to FactSet.
Slowing global economic growth will also weigh on stocks in both the U.S. and Europe. Kapteyn expects global growth will slow to just 2.1% on a year-over-year basis in 2023, the lowest rate since 1993. Currently, the International Monetary Fund expects the global economy will grow by more than 3% this year.
The S&P 500 has fallen 20.4% so far this year, compared with a drop of 9.5% for the Dow DJIA, +3.70% and 32.9% for the Nasdaq Composite. All three major U.S. benchmarks were trading lower on Wednesday, leaving them on track to fall for the first session after three straight days in the green.