The overlooked red flags in earnings mean it's time to get ready for stock turbulence, a top BNY Mellon analyst says

• Investors are overlooking info in earnings reports that suggest a recession is ahead, a BNY Mellon analyst said.
• That means they should be preparing for more market turbulence, after this year's rally reversed course.

Stock investors should get ready for a bumpy ride ahead, as they're overlooking some warning signs of recession in this season's earnings reports, according to a BNY Mellon investment chief.

The focus in markets has for months been on the Federal Reserve's path for interest rates, and on inflation and other data that could influence that policy.

But that has meant investors have failed to notice some key signs in corporate earnings reports, Jake Jolly told Bloomberg TV.

"So certainly macro is still in the driver's seat, but I think what we need to pay attention to is what we are seeing on the micro," Jolly said Tuesday.

"I think probably this market is overlooking some of the information that did come through in the earnings season."

Jolly, head of investment analysis at BNY Mellon Investment Management, described the season so far as underwhelming, and noted corporations have been guiding lower on future earnings.

"Really, the big takeaway is the speed with which we've seen downward revisions looks a lot like heading into a recession," he said.

"So I think you need to be preparing in terms of your asset allocation — preparing for more market turbulence."

Concerns that the Fed's aggressive monetary policy would tip the US into recession helped deliver a dismal 2022 performance for stocks. But this year kicked off with a market rally, as investors grew optimistic that cooling inflation would prompt the US central bank to shift course.

That has changed in recent weeks as the market realized that all signs suggest US interest rates will remain higher for longer. The Dow Jones Industrial Average, the S&P 500 and the Nasdaq Composite all logged monthly losses in February.

"We had these very optimistic risk-on moves in January. February — I think the story is really about sort of economic reality becoming priced back into the market," Jolly said.

That said, recession is not a foregone conclusion, and that's why stocks are holding at valuations even at 18 times their forward earnings, according to the investment analysis head.

The best downside protection in this type of market is bonds, according to Jolly, which he said look much more attractive than equities when it comes to total returns this year.

"It is still going to be the year of the bonds, we just have to be a bit more patient," he said.