Dow Jones, Nasdaq, S&P 500 weekly preview: Recession fears cloud equities outlook

Stocks fell sharply on Friday following a surprisingly weak July jobs report, fueling concerns about a potential economic recession.

The broad market index dropped 1.84% to close at 5,346.56. The Nasdaq Composite fell 2.43% to 16,776.16, marking a decline of over 10% from its recent peak. The Dow Jones Industrial Average decreased by 610.71 points, or 1.51%, ending the day at 39,737.26.

The sell-off came as investors reacted to a significant slowdown in U.S. job growth for July, coupled with a rise in the unemployment rate to its highest level since October 2021. According to the Labor Department, nonfarm payrolls increased by only 114,000 in July, down from 179,000 in June and falling short of the 185,000 forecasted by economists surveyed by Dow Jones.

The Nasdaq has now entered correction territory, having dropped more than 10% from its all-time high. Meanwhile, the S&P 500 and Dow are 5.7% and 3.9% below their record highs, respectively.

The negative sentiment persisted on Monday, with all major stock futures trading in the red as Japan’s Nikkei and Topix indexes each plummeted more than 12%.

Meanwhile, Nvidia (NASDAQ:NVDA), one of the favorite AI-related stocks and the key driving force behind the recent bull market, saw its shares tumble 13% in premarket trading.

The sharp sell-off prompted economists to reevaluate their interest rate cut predictions as they believe the Federal Reserve will now have to act earlier than expected to support a slowing economy. Goldman Sachs (NYSE:GS) anticipates three consecutive 25 basis points cuts by year-end in September, November, and December.

Looking ahead to this week, investors will focus on key economic indicators for further insights into trends, particularly the ISM services report on Monday and the jobless claims report on Thursday.

“We estimate that the ISM services index rebounded 1.7pt to 50.5 in July, reflecting partial convergence toward our non-manufacturing survey tracker (which stands at 52.3 for July) but a potential headwind from seasonality,” Goldman economists said in a note.

In addition, several Fed officials will speak in the coming days.

This week's earnings spotlight: SMCI, Caterpillar , Walt Disney

Apart from the disappointing July employment data, investors are also concerned about the elevated valuations in the wake of the AI rally, with rising geopolitical risks in the Middle East also adding to the risk-off sentiment.

Although all Big Tech companies have already unveiled their latest earnings, several other important reports are expected this week.

Specifically, this includes earnings reports from Super Micro Computer (NASDAQ:SMCI), Caterpillar (NYSE:CAT), The Walt Disney (NYSE:DIS) Co., and Eli Lilly (NYSE:LLY), among others.

What analysts are saying about US stocks

BTIG: “It's been a long time coming, but the fulcrum from markets trading 'bad news is good' to 'bad is bad' appears to be here. Therefore, lower rates are likely to be met with lower stock prices, as we have seen over the last couple of days. As far as the SPX goes, the recent pullback gets us closer to a possible washout, but we still see some risk towards 5200. Internals have weakened, but given the rotation into defensives, they remain far from what we typically see at tradable lows.”

Wedbush: “We are getting inbounds from investors around the world today/over the weekend asking us if this tech bull market and historic run for tech stocks is over? It's NOT in our view and this is just a white knuckle moment in a multi-year bull run for tech stocks that need hand holding. We have battled through this bull/bear debate a number of times over the past few years as well as the last few decades covering tech stocks on the Street. Our view its a soft landing environment, the Fed is in a major cutting cycle the next 18 months, AI represents a new build out for the tech world not seen since the start of the Internet, AND this is not a bubble and tech vendors will start to show the monetization/use cases/growth over the next 6-9 months to validate the valuations.”

Morgan Stanley (NYSE:MS): “It’s worth noting that valuations are sensitive to earnings revisions breadth, which turned negative last month. The last time S&P 500 earnings revisions breadth rolled over into negative territory was last fall. Between July and October 2023, the market multiple declined from 20x to 17x. Two weeks ago, the P/E was 22x, and it is now at 20x. If earnings revisions continue to fade, as the seasonal trends suggest they will, it’s likely these valuations have further to fall. With our 12-month base case target multiple at 19x, the risk/reward for equities broadly remains unfavorable. Under the surface of the market, we continue to recommend a quality + defensive (rather than growth) bias.”

RBC Capital Markets: “We’ve thought a pullback in the S&P 500 would likely settle out in the 5-10% range. Ones significantly more than that in recent decades tend to be associated with growth scares (10-20% declines) or recessions (which most pullbacks 20% or more end up being associated with). We still have questions about the jobs report, specifically on weather. For now, 10% remains our assumption for how deep a pullback could go but we’re monitoring the jobs discussion closely for risk of a growth scare settling in given how skittish investors appear to be.”

UBS: “Similar to what we witnessed amidst the small-cap rotation a few weeks ago, the degree of moves was clearly exacerbated by stretched positioning, in our view. The difference today is there is fundamental backing to elevated levels of risk premia, from both a macro and earnings perspective. But have we gone too far, too fast? Aggressive rate cuts priced into the market post-NFPs and the coincident move in the front-end of the yield curve appears to be an overshooting, per our Rates Strategists. Our US Equity Strategists flagged that VIX > 25 has historically been a buying opportunity for stocks. We echo this sentiment, but note the risks appear to be skewed more asymmetrically to the downside.”

This article first appeared in Investing.com